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Mark Vickery

Kellogg Beats EPS, Sales In Line

K PG

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Kellogg Company’s (K - Analyst Report) third quarter 2012 earnings per share of 86 cents per share (excluding integration costs related to Pringles) beat the Zacks Consensus Estimate of 81 cents per share by 6.2%. The third-quarter earnings also beat the prior-year quarter earnings of 80 cents by 7.5%, driven by robust organic sales growth performance, which offset the headwinds from last month’s product recall.

We remind investors that Kellogg recalled certain packages of Mini-Wheats cereals last month. Kellogg reaffirmed its organic sales growth and earnings guidance for 2012.

Revenue & Margins

The world’s largest cereal maker reported revenue of $3.7 billion in the quarter, up 12.3% year over year. Acquisitions added 11.3% to top-line growth, while currency pulled it down by 1.6%. Accordingly, organic revenue growth (excluding impact of acquisitions, dispositions and foreign exchange) was 2.8%.

Improving revenue trends in North America and strong performance of its Pringles business, acquired from Procter & Gamble (PG - Analyst Report) in June this year, drove the top-line growth in the quarter. Volumes were almost flat while price/mix added 2.7% to sales growth. Revenues were however in line with the Zacks Consensus Estimate of $3.7 billion.

Kellogg’s adjusted operating profit declined 4.9% due to commodity cost inflation, product recall costs and investments in brand building.

Management was expecting to see better revenue and profit growth in the second half as compared to the not-so-great second quarter performance. The overall third quarter results are in line with management expectations.

Segment Discussion

Most of the business segments delivered decent year-over-year revenue growth in the quarter.

North American Business: Kellogg North America’s sales increased 11.1% from the prior-year quarter to $2.5 billion in the third quarter. Organically, segment sales increased 3.7% in the quarter including the headwinds from the recall.

While each of the U.S. Morning Foods and Kashi, U.S. Specialty, North America, and Other businesses recorded an organic sales growth of over 5%, the U.S. snacks business grew only 0.3%. The Morning Foods and Kashi business gained due to strong performance of both the cereal and toaster pastry segments. The Specialty business was driven by good performance of the frozen foods business.

Price/mix added 3.2% to revenue growth, while volumes grew a paltry 0.5%. Organically operating profit declined 1.6% as sales growth was offset by the product recall costs.

International: Kellogg International sales improved 14.8% to $1.3 billion from the prior-year quarter. The segment sales increased 1% organically, in line with management expectations of delivering better performance than the second quarter’s decline. Europe declined 2.5% organically, better than last quarter’s performance.

In Europe, the company saw increased growth in U.K. Asia Pacific grew 6.8% in the quarter driven by good performance in Australia, South Africa, and India. Latin America grew 3.6% in the quarter.

Kellogg International's operating profit decreased 10.5% organically due to weakness in Europe and higher brand building investments in Asia Pacific and Latin America.

2012 Guidance

While Kellogg maintained its full-year 2012 organic sales growth guidance, it lowered its organic operating profit outlook due to headwinds from the product recall.

For 2012, the company expects its organic net sales growth guidance in a band of 2%–3%. Internal operating profit for 2012 is expected to decline in the range of 4%-6%, higher than prior expectations of 2%–4%. The organic revenue and operating profit guidance excludes the impact from the Pringles acquisition.

Kellogg expects its reported earnings per share to range between $3.18 and $3.30 in fiscal 2012. The guidance however includes impact from the Pringles acquisition and now the product recall costs.

Our Recommendation

We currently have a Neutral recommendation on Kellogg. The stock carries a Zacks #3 Rank (a short-term Hold rating).

We are optimistic about Kellogg’s solid brand positioning, its geographic diversity and cost-saving efforts, especially its supply-chain initiatives. Moreover, we are encouraged by the growth potential, diversification and international presence that the Pringles deal provides. However, its sluggish cereal business, challenges in Europe and rising input costs keep us on the sidelines.

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