Kellogg (K) Q2 Earnings Beat; Increases View On Savings

Kellogg Company (NYSE:K) delivered better-than-expected second-quarter 2016 earnings on the back of robust cost savings. However, sales fell short of expectations as the improved U.S. cereal trends seen in the fourth quarter could not be sustained.

The company increased its earnings guidance for 2016, as it now expects higher savings from zero-based budgeting in North America, along with the rollout of a similar program in its international regions. However, it has trimmed its sales outlook owing to currency headwinds.

Earnings Beat

Second-quarter adjusted earnings of 91 cents per share beat the Zacks Consensus Estimate of 90 cents by 1.1%. Earnings dipped 1.1% year over year due to significant currency headwinds.

Excluding currency headwinds of 9 cents (mostly from the Venezuela business), earnings increased 8.7% year over year primarily driven by better profit-margin performance in North America.

Adjusted earnings exclude costs associated with Project K, a mark-to-market loss and certain other items. Including these items, however, the company’s earnings came in at 79 cents per share, up 25.4% year over year.

Revenues Miss

Kellogg reported revenues of $3.268 billion, down 6.6% year over year. Significant currency headwinds from the re-measurement of the Venezuelan business in mid-2015 resulted in the underperformance. Revenues also missed the Zacks Consensus Estimate of $3.347 billion by 2.4%.

Currency hurt sales by 15.1% in the quarter. Acquisitions and dispositions had a negative impact of 0.1%. Accordingly, organic revenues (excluding the impact of acquisitions, dispositions and foreign exchange) improved 8.6%, better than 6.6% in the previous quarter, mainly driven by extraordinary inflation in Venezuela. Excluding Venezuela, organic sales growth decreased modestly.

Volumes declined 1.6%, more than 0.7% drop in the previous quarter. On the other hand, price/mix added 10.2% to sales, better than 7.3% last quarter, due to accelerating levels of inflation in Venezuela.

Profits Rise Marginally

Kellogg’s adjusted operating profit grew a marginal 0.3% to $507 million due to currency headwinds of 10.3%. Profits deteriorated in Latin America and Europe but improved in North America and Asia-Pacific.

However, excluding currency impact, adjusted operating profit surged approximately 10.6% on strong Project K cost savings.

Segment Discussion

North America: Kellogg’s North America sales declined 3.4% (down 3.2% organically) year over year to $2.21 billion. However, the decline in organic revenues was wider than a 1.2% drop in the previous quarter. Volumes declined 2.4%, wider than a 1.1% decrease in the previous quarter. Price/mix was down 0.8% as against growth of 0.1% in the previous quarter. Adjusted operating profit rose 5.3% organically in North America.

On a constant-currency basis, sales of U.S. Morning Foods segment declined 2%.

The improved cereal trends witnessed in the fourth quarter of 2015 could not be sustained in the first two quarters of 2016 though the company continued to gain market share.

The cereal business has slowed down since 2012 due to sluggish category growth. This is due to lower demand as a result of competitive pressure from other breakfast alternatives including yogurt, eggs, bread and peanut butter.

In order to improve sales performance, Kellogg launched campaigns supporting the breakfast occasion. It is also investing in in-store capabilities, product and packaging innovation as well as reformulation of many existing products to drive demand. Specifically, the company completely redesigned the Special K brand and re-launched it as a healthy lifestyle brand to cater to changing consumer trends.

The U.S. Snacks businesses, which have been struggling since 2013 due to weak volumes, declined 3.9%. The U.S. Specialty Channels business improved 0.5% organically, while the North America Other business deteriorated 6.4%.

Europe: Segment revenues of $629 million declined 3.2% due to currency headwinds. Organically, sales were flat in the second quarter as against a decline of 0.9% in the last quarter. Organic operating profit grew 3.7% in Europe.

Latin America: Segment revenues of $204 million plunged 37.9% due to currency headwinds. Organically, sales soared 111.9% on inflation-based pricing in Venezuela. Organic operating profit increased 66.6% in Latin America.

Asia Pacific: Segment revenues of $228 million declined 2.9% due to currency headwinds. Organically, sales increased 3.4%. Organic operating profit grew 17.5% in the Asia Pacific.

2016 Outlook Raised

The company has raised its guidance for earnings and operating profit in 2016 owing to better-than-expected first-half profit in inflationary Venezuela, and an increased forecast for operating profit margin for the rest of the business. However, it has trimmed its sales outlook.

Net sales growth, excluding Venezuela, is now expected at the low end of the previously guided range of flat to 2% growth. Currency is expected to have a more negative impact due to further weakening in currency exchange rates for Venezuela and for other currencies, particularly in the aftermath of Britain's vote to exit from the European Union. Including benefits from Venezuela, organic sales growth is expected in the range of 4%–6%.

The company now expects adjusted constant currency earnings (including the impact of Venezuela) in the range of $4.11-$4.18 per share, up from the previous guidance of $4.00-$4.07. However, including currency impact, adjusted EPS guidance was between $3.58 and $3.65.

Adjusted constant currency operating profit growth, including benefits from Venezuela, is now expected in the range of 15%-17%, up from 11%–13% expected previously.

Kellogg holds a Zacks Rank #4 (Sell). Better-ranked food stocks include B&G Foods, Inc. (NYSE:BGS) , Ingredion, Inc. (NYSE:INGR) and The J. M. Smucker Co. (NYSE:SJM) . All of them sport a Zacks Rank #1 (Strong Buy).