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Kellogg Company (K - Analyst Report) reported lower profits and revenue in the second quarter of 2014 as cereal sales in developed markets remained challenging. Moreover, management lowered its full-year outlook after witnessing a poor run in the first half of the year. Shares declined 1% in pre-market trading.

Second-quarter adjusted earnings of $1.02 per share were in line with the Zacks Consensus Estimate as well as management’s internal goal of recording earnings of approximately $1.02 per share quarter. Earnings were flat with the prior-year quarter as currency benefits offset weak revenues and profits. The earnings results included an unexpected 2-cent benefit from currency translation.

Adjusted earnings exclude integration costs related to the Jun 2012 Pringles acquisition, costs associated with Project K restructuring program and a mark-to-market loss. Including these items, reported earnings were 82 cents per share, down 15% year over year.

 

Revenues & Margins Weak

The world’s largest cereal maker reported revenues of $3.69 billion in the quarter, down 0.8% year over year. Revenues also missed the Zacks Consensus Estimate of $3.71 billion.

Management failed to live up to its internal expectation of returning to positive top-line growth in the second quarter after recording sales decline in the previous two quarters due to weakness in the core cereals business in the developed countries.

While volumes declined 2.5%, price/mix added 1% to sales. Currency benefited sales by 0.7% while acquisitions and dispositions had a neutral impact in the quarter. Accordingly, organic revenues (excluding the impact of acquisitions, dispositions and foreign exchange) declined 1.5% due to another quarter of soft sales in the U.S. However, the international business improved from last quarter and Pringles business continued to do well.

Kellogg’s adjusted operating profit declined 7.2% to $567 million comparing unfavorably with management’s expectation of it declining only slightly. Lower sales and higher brand building investments took a toll on profits in the quarter. Profits were weak in the U.S. as well as in Asia-Pacific but the same improved in Europe and Latin America.

Segment Discussion

North America: Kellogg North America sales decreased 3.7% (down 3.4% organically) from the prior-year quarter to $2.35 billion hurt by sales decline in cereals and snacks. Price/mix added 0.6% to revenue growth, while volumes declined 4%.

Organically, the U.S. Morning Foods business, which includes cereals such as Corn Flakes and Special K, declined 4.9% in the quarter. Kellogg’s U.S. cereal business, accounting for 40–45% of sales, has been performing poorly since 2012 due to sluggish category growth. Lower demand for cereals due to competitive pressures from alternatives such as yogurt, eggs, bread and peanut butter is hurting cereal category growth. Though the company is trying to reinvigorate this segment through innovation and aggressive marketing campaigns, these activities are yet to show results.

The U.S. Snacks businesses declined 2.7% in the quarter, failing to maintain the improvement witnessed in the first quarter. The U.S. Specialty Channels business improved 1.4% organically and the North America Other business went down 4.9%.

Adjusted operating profit declined 8.7% in the quarter due to weak volumes and increased brand building costs.

International

The international segment improved from a softer performance in the previous quarter due to significant sales rebound in Latin America.

During the quarter, revenues in Europe improved 0.7% organically to $772 million. Asia Pacific improved 0.5% organically to $243 million. Latin America improved 6.9% to $320 million due to pricing gains and innovation.

Adjusted operating profit improved 5.1% in Europe and 6% in Latin America but declined 65.2% in Asia Pacific.

2014 Guidance Lowered

In 2014, organic revenues are expected to decline between 1% and 2%, lower than prior expectations of increasing approximately 1%. The sales guidance excludes the impact of currency as well as an extra week in the year.

Also, adjusted operating profit is expected to decline between 1% and 3% comparing unfavorably with the previous guidance of its remaining flat or grow up to 2% in the year.

Adjusted earnings per share (excluding currency headwinds) are expected in the range of $3.81–$3.89 per share, lower than prior range of $3.89–$3.97. The new earnings guidance represents negative 1% to positive 1% growth rate versus prior expectation of a range of positive 1–3%.

The adjusted operating profit and earnings guidance exclude the impact of market adjustments, costs related to Project K and the expected benefit from an extra week in 2014. The 53rd week is expected to add 7 cents to reported earnings per share for the year. Moreover, currency benefits are expected to add another 3 cents to earnings. Including the 53rd week benefit and currency tailwinds, earnings per share are expected to range between $3.91 and $3.99.

The organic sales, adjusted operating profit as well as earnings per share guidance are far below the long-term targets — suggesting that 2014 could prove to be worse than 2013.

Other Stocks to Consider

Kellogg currently carries a Zacks Rank #4 (Sell). Better-ranked food stocks include Treehouse Foods, Inc. (THS - Snapshot Report) Pinnacle Foods Inc. (PF - Snapshot Report) and J&J Snack Foods Corp. (JJSF - Snapshot Report). While Treehouse carries a Zacks Rank #1 (Strong Buy), Pinnacle Foods and J&J Snack Foods carry a Zacks Rank #2 (Buy).

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