Costs, Europe Dent Kellogg's Profit

Kellogg Company ( K - Analyst Report ) posted second quarter 2012 earnings per share of 79 cents (excluding the impact of transaction and integration costs and benefit associated with the acquisition of the Pringles business), missing the Zacks Consensus Estimate of 84 cents per share.

The second quarter earnings also lagged the prior-year quarter earnings of 94 cents per share by 15.6%. Weak revenues in Europe and Asia-Pacific, high commodity costs and investments in supply chain initiatives led to the earnings miss in the quarter.

The world’s largest cereal maker reported revenues of $3.5 billion, up 2.6% from the year-ago quarter. The sales growth was mainly attributable to the better performance of U.S. cereals business and significant growth in its Pop-Tarts business.

Organically (excluding impact of acquisitions, dispositions and foreign exchange), revenues went up 2.3% year over year. Revenues were above the Zacks Consensus Estimate of $3.4 billion. Volumes were down 6%, while price/mix added 2.9% to sales growth.

Operating profit was $485.0 million, down 10.7%. Kellogg’s adjusted operating profit was also down 5.0% due to commodity cost inflation, sluggish European results and investments in supply chain initiatives.

From the fourth quarter of 2011, the company started reporting its business under seven segments: U.S. Morning Foods and Kashi; U.S. Snacks; U.S. Specialty; North America Other; Europe; Latin America; and Asia Pacific. The first four segments form a part of the company’s North American Business and the last three are part of the International business.

North American Business: Kellogg North America sales increased 5.9% from the prior-year quarter to $2.4 billion in the second quarter. Organically, segment sales increased 3.9% in the quarter that included a 0.3% benefit from volume and 3.6% benefit from price/mix.

The segment posted internal net sales growth of 4.1% in the U.S. Snacks business, a 6.3% increase in the U.S. Specialty business and an 8.9% jump in the North America Other segment. The U.S. Morning Foods and Kashi posted an internal net sales decline of 1.2% in the reported quarter.

Operating profit in the North American region went up 4.8% in the quarter to $425 million, while it increased 3.3% organically.

International: On the other hand, Kellogg International sales declined 3.8% year on year to $1.1 billion. The international sales decreased 0.7% organically.

The segment posted internal net sales growth of 6.8% in Latin American. However, the internal net sales in the European region declined by 3.6%, owing to macroeconomic headwinds. The Asia-Pacific region also witnessed a 2% dip due to soft results in Australia.

Operating profit of Kellogg International declined 30.9% in the second quarter and internal operating profit decreased 22.5%, dragged by weak margins in Europe.

Guidance

Kellogg reaffirmed its 2012 financial outlook and expects its internal net sales growth in a band of 2%-3%. Operating profit for 2012 is expected to decline by 2%-4%.

Kellogg continues to expect earnings per share in the range of $3.18-3.30 for fiscal 2012. The guidance includes the impact from the pending acquisition of the Pringles business from retail giant Procter & Gamble Company ( PG - Analyst Report ) .

The Zacks Consensus Estimate for 2012 is pegged at $3.35 per share.

Our Recommendation

Overall, we are positive about the company’s strong market position and its continued focus on brand building and innovation. The Pringles deal will provide additional growth opportunity in fast-growing emerging nations. It will also reduce Kellogg’s dependence on its mainstay cereals business, which is somewhat struggling. The sluggish cereal business and increasing pressures in Europe keep us on the sidelines.

Currently, we have a Neutral recommendation on Kellogg Company. The stock carries a Zacks #3 Rank in the near term (Hold rating).