Cereal Makers Are Feeling the Crunch

Cereal is a breakfast staple, but that may be changing. Not as many people are eating cereal these days, and the companies that make popular cereal brands are feeling the pressure.

Kellogg (NYSE: K  ) announced that it was cutting approximately 2,170 jobs (7% of its workforce) over the next four years as part of a cost-cutting program known as "Project K." General Mills (NYSE: GIS  ) cut 850 jobs last year to reduce costs as well, though the Cheerios maker has still managed to eek out slow-but-steady growth this year. 

Cereal losing its flavor
Companies that make breakfast cereals have faced declining demand for the past few years. Cereal sales volumes have dropped approximately 2% to 3% per year since 2010, due to factors such as an increased number of ready-to-eat alternatives, increased scrutiny regarding childrens' breakfast options, declining birth rates, and the fact that approximately half of the U.S. population is skipping breakfast entirely. Slow recovery from the Great Recession has also increased pressure on cereal makers as customers find their grocery budgets significantly restricted.

A seat at the table
With cereal sales slowing, cereal manufacturers are looking for other growth prospects. Expanding beyond the cereal aisle was a major reason that Kellogg purchased the Pringles chip brand from Procter & Gamble last year. Along with its Keebler snack line, the Pringles purchase made Kellogg the second-largest snack food company in the world behind PepsiCo. The company has been very active with the Pringles brand since the acquisition finalized, introducing a number of limited-time offerings to try and drive Pringles sales.

General Mills has also been making strategic acquisitions, using them to fuel international growth for some of its brands. This strategy goes hand-in-hand with the company's expansion of its Yoplait yogurt brand (which itself was an acquisition in 2011) to better compete with the ongoing Greek yogurt trend. Greek yogurt now makes up approximately 30% of all yogurt sales, but it currently only accounts for 10% to 15% of the company's yogurt sales.

Post Holdings (NYSE: POST  ) is also using acquisitions to fuel its growth outside of the cereal aisle. The Grape-Nuts maker recently announced $700 million in acquisitions to purchase Golden Boy Foods and Dymatize Enterprises in separate transactions. The two private label companies will help Post expand into nut butters and dried fruit products (via Golden Boy) as well as nutritional supplements and protein powders (via Dymatize) to add diversity to its product offerings.

Feeling the heat
While decreasing demand for primary products can hurt any company, cereal manufacturers have tried to avoid the worst of the damage through diversification and cost reductions. While company-wide sales have grown, increased sales aren't always enough to make a profit.

In the recent third quarter that ended on Sep. 28, Kellogg reported a minimal loss as compared to the previous year's quarter; net sales dropped by 0.1% due to negative movement in two U.S. sales categories (including morning foods) and a nearly 10% drop in Asia Pacific sales. Year to date, however, consolidated sales are up 6.2% with the only loss being reported in U.S. morning foods sales. The company pays a quarterly dividend of $0.46 per share with a payout ratio of 48.9%, and this dividend has been growing steadily for the past eight years.

General Mills announced a $321.7 million increase in net sales in its first-quarter 2014 results that were released on Sep. 18. Unfortunately, this was overshadowed by increases in administrative and sales-related costs; in the end, the company saw a loss in operating profits from the previous year's quarter of $45.3 million and an EPS loss of $0.13 per share. Despite this, the company increased its quarterly dividend to $0.38 per share (a $0.05 increase from the previous year's dividend).

In its quarterly report released on Aug. 8, Post told a tale similar to General Mills. Net sales were up for the quarter by $15.4 million, but increased cost of sales and administrative expenses resulted in an overall profit loss of $17.3 million. The company's EPS loss was even more drastic than General Mills', dropping $0.43 to a mere $0.03 per share compared to the year-ago quarter.  Post announced a dividend on its Series B convertible preferred stock earlier this year, but doesn't offer a dividend on its common stock.

The bottom line
While cereals are a staple breakfast food found in approximately 90% of American homes, they are currently enduring a multi-year trend of waning popularity, and the companies that make them are feeling the crunch. Every major cereal manufacturer is attempting to diversify away from breakfast foods due to the weakness in demand, but diversification alone won't make them profitable.

With all three of the cereal makers discussed here showing profit and EPS losses due to rising costs, getting those costs under control has to be a priority. While cost-cutting measures are being enacted, potential investors should wait until costs actually start dropping or share prices drop to better entry points before buying in. These companies have strong brands, but brand strength can only carry you so far when profits are headed south.

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