English poet William Blake, once said that you never know what is enough until you know what is more than enough. Kellogg (NYSE:K) management and shareholders can sympathize with that viewpoint, now that it looks as though the company cut much too deep with its "K-LEAN" cost-cutting initiatives. Although this is an embarrassing stumble for a sterling company, the bigger issue with the stock may be its valuation and its presently pokey overseas growth.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

A Disappointing Third Quarter
Kellogg stock has long enjoyed a generous benefit of the doubt from the Street, largely because the company was seldom disappointing. This third quarter was a poor exception, though, as both sales and earnings faltered.

Revenue rose just 5% this quarter (or 3% on constant currency), as 5% pricing growth was offset by a nearly 2% decline in volume. On its own, this is not terribly worrisome, as Kraft (NYSE:KFT), General Mills (NYSE:GIS) and ConAgra (NYSE:CAG) have all been tweaking prices and incurring some volume pressure as a result, though most of these rivals seem largely past the volume hits. Odd for this group, Kellogg saw North American growth of 4% but currency-neutral international growth of just 2%, and Kellogg's U.K. business seems to be losing shares to Kraft and Nestle (OTC:NSRGY).

Profits were even more disappointing. The company's lean operating initiative went right through lean and into under-nourished. As a result, the company is backtracking and reinvesting in its supply chain. This led to a two and a half point drop in gross margin, and a 14% drop in reported operating income. Operating income was even worse on an internal basis (down 16%), but a lot of this decline was a product of new supply chain costs and restatements of incentive compensation. For those who want to give the company a break, "core" operating earnings actually looked quite a bit better. (For related reading, see Zooming In On Net Operating Income.)

Where's the New Normal on Costs?
The seeds of a tough cost inflation environment were sown a year ago, when terrible wheat harvests around the world led to price spikes. As I suggested, at the time, what goes up in the farm world can go right back down the next year, and that has proven to be the case. An article in "Bloomberg," reported on Friday, talked about how this year is shaping up as the second-largest wheat harvest on record, and prices are heading down.

Clearly, wheat is not the only cost that affects Kellogg. Corn and soybean prices are still relatively high. Archer-Daniels-Midland Company (NYSE:ADM) is probably going to try to follow Cargill, and push through higher corn syrup prices, and transportation, fuel and packaging prices have not eased off much, if at all.

What About the Overseas Business?
The bigger worry, I have, about Kellogg, today, is the unimpressive overseas performance that the company is currently seeing. Asia-Pacific sales, for instance, grew just 2% on a 5% volume decline, and ,frankly, volume was down in every single geography. Kellogg needs to be gaining on Kraft, Nestle, PepsiCo (NYSE:PEP) and Unilever (NYSE:UL), not falling behind.

About two-thirds of the company's revenue comes from the U.S., and that has to change if Kellogg wants to post the sort of growth it needs to make the stock interesting. Unfortunately, this is not a free call option - it will require investments in supply chains and marketing, and some investors will not like the margin pressure that creates, even though long-term shareholders should be supporting such moves. (For more on calls, see The Basics Of Covered Calls.)

The Bottom Line
Kellogg is often a little expensive relative to other food companies, because of its quality and reliability. That reputation may have a few dings and scratches now, but management can likely smooth it over by limiting the negative surprises in the next few quarters.

That said, and acknowledging that Kellogg is a company I have long liked, it's hard to get excited about the stock right now. It's cheaper (and arguably better-run) than ConAgra, Kraft and General Mills, but still not cheap. For the time being, PepsiCo and ADM may actually be the better bargains in food for investors.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  7. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  9. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  10. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!