Kellogg Feels Inflation Pressure

Kellogg Company (K - Analyst Report), the leader in ready-to-eat cereals, continues to report consistent sales and earnings growth, reducing debt and repurchasing shares by focusing on brand building and profitability. However, the recent commodity inflation is pressuring margins and the trend is expected to continue at least through 2008. The Hold rating is maintained.

Kellogg has focused on brand building through new product innovation and improving the product mix by concentrating on optimal price/mix combinations. Marketing efforts are aimed towards the more profitable cereals and snacks business, thereby resulting in increased sales and expanded margins. Kellogg is also focused on integrating infrastructure and reducing costs.

However, the management expects inflationary trends to continue with input costs (fuel, energy, commodity, and benefits) forecasted to exceed realized savings in 2008. Commodity inflation is expected to impact earnings by 65 cents per share in the current fiscal year.

Moreover, as the retail grocery trade continues to consolidate and mass marketers and becomes larger, large retail customers may seek to leverage their position to improve their profitability at the expense of Kellogg’s.

During the last five years, a period of relatively stable and modest earnings growth, Kellogg has traded in a narrow P/E range of 16.6 to 21.7. The stock is currently trading at a P/E multiple of 18.2. Given that cash flow has been increasing consistently and EPS have exhibited modest growth, the stock is expected to trade at the top-end of the historical valuation range. Hence, the target price is $55.25 based on a 20 P/E multiple on trailing 12 month earnings.

Read the full analyst report on K