Kellogg May Be Worth A Nibble

Kellogg (NYSE: K) controls more than 30% of the domestic cereal market and is also a leader in many international markets. Recent performance, as evidenced by a challenging third quarter, has been uninspiring and has pushed the share price down. This represents a somewhat compelling opportunity to pick up the shares, as they aren't a steal at current levels but do have a number of investment merits. IN PICTURES: How To Make Your First $1 Million

Third Quarter Review

Reported net sales fell 3.7% to $3.2 billion. Geographically, North American sales accounted for 67.5% of total sales and fell 3% as cereal sales were particularly weak. The retail snack category saw flat sales, while frozen and specialty foods witnessed a 5% top-line decline. In the latter product area, management cited trouble rebuilding the Eggo waffle branded business.

International sales - which include Europe, Latin America and the Asia Pacific regions - struggled even more, falling 6%, though only 2% on an organic basis when stripping out negative currency fluctuations. The European cereal and Russian snack food categories were singled out for challenging trends.

Every region experienced a fall in profitability as well. North American profits fell 3% as higher manufacturing costs and advertising ate into margins. International profits reported a more severe 11% decline. Organic growth fell a less severe 5%, but it fell as a modest increase in European profitability was offset by declines in the other two overseas regions.

Total company operating income fell 4.6% to $541 million, or 17.2% of sales. Net income ended up falling 6.4% as higher income taxes ate into the bottom line. Share buybacks helped temper the fall in diluted earnings to 4.3%, as earnings came in at 90 cents per diluted share. (For related reading on buybacks, see A Breakdown Of Stock Buybacks.)

Outlook

For the year, management expects organic sales to fall 1% while earnings increase 4-5%. Analysts currently project $3.31 EPS for the year. This represents lower guidance than previously given, and the company also will use $500 of cash flow to fund its retirement plans.

For fiscal 2011, Kellogg anticipates low-single-digit organic sales growth and a similar increase in earnings.

Bottom Line

Kellogg attributed its weak quarter to struggles in a number of cereal markets, competition and a cereal recall. Commodity prices also increased and are adversely affecting other industry players including General Mills (NYSE: GIS), Kraft (NYSE: KFT), Sara Lee (NYSE: SLE) and the Quaker Oats division of PepsiCo (NYSE: PEP).

In Kellogg's case, the hit from product recalls will subside and, like others in the industry, the company will likely be able to increase prices to offset input cost inflation. At a forward P/E of just under 15, the shares are not a steal, but they are at the low end of Kellogg's five-year earnings multiple range. This represents a reasonable entry point for a company that has a consistent and enviable track record of leveraging mid-single-digit sales into double-digit earnings growth.

A current dividend yield of 3.2% is also above market averages. This should appeal to income-oriented investors who are also interested in seeing their yield grow over time along with company cash flows.

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