It's Crunch Time for Kellogg's Cereal Business

Just before the pandemic hit in 2020, Kellogg (K 1.49%) basically completed a major portfolio overhaul. It sold slower-growing brands and added faster-growing ones as it shifted toward snacking. However, it still has a sizable cereal business, which consumers know well. The only problem is that the cereal division hasn't been hitting on all cylinders. 

A hazy, crazy period 

The fact that Kellogg's portfolio revamp ended just as the coronavirus pandemic began is very important. That's because social distancing, working from home, and the closure of nonessential businesses led to a spike in buying food at grocery stores to eat at home.

In fact, 2020 was a pretty good year for most food makers. However, this was more of a windfall moment than a lingering change in consumer habits. Indeed, as 2021 got underway, sales started to pull back to more reasonable levels.

Image source: Getty Images.

To smooth out distortions caused by the pandemic, Kellogg has been providing investors with two-year, compound growth rates. Consider that the company's organic sales grew 7% in the first nine months of 2020, but just 3% for the same period in 2021. However, if you look at the two-year compound annual rate, sales growth evens out to a healthy 5%, suggesting that Kellogg's turnaround plans are progressing fairly well. 

Yet, the company's cereal business, which made up roughly a third of overall sales in 2020 could be facing more challenges. In its third-quarter 2021 conference call, Kellogg described that business as "flat-ish." Management said this was roughly in line with the industry, but could there be other factors involved too?

What about the competition?

Kellogg's biggest adversary in the cereal space is General Mills (GIS 1.93%). In its own third-quarter presentation, General Mills noted that it has increased market share each year since 2018 -- from 31.3% to 34%. A few percentage points may not sound like much, but in a mature business like cereal, market share is critical. So this increase is in fact a huge success.

Since the cereal category doesn't really grow much, the question is this: from whom did General Mills take market share? While General Mills doesn't name names, it points out that the No. 2 brand has lost share over the same span, dropping from 31.2% to 29%. It's not a huge leap here to think that General Mills is perhaps talking about Kellogg.

Data source: General Mills.

When you look at General Mills' take on the cereal sector, Kellogg's sales start to look a lot less solid over the longer term. That's even more true when considering that eat-at-home demand has been unsustainably strong over the past couple of years. 

To be fair, Kellogg has been dealing with some notable headwinds specific to its cereal division. For example, there was a fire at one of its plants. And, of course, it recently had to deal with an employee strike, which has now been resolved. Both of these events, however, were fairly recent, causing the company some temporary problems.

It wouldn't be surprising to see Kellogg's cereal division hit a low point in the fourth quarter of 2021, putting a crescendo of sorts on its domestic cereal trend. On a positive note, the company's foreign cereal business has been stronger than the domestic one, which is nice, but the U.S. cereal business is bigger and more important. And Kellogg needs to turn things around here, or at least stem the apparent market-share bleed.

A fourth-quarter pass -- but then what?

As noted, the cereal business will likely be weak in the fourth quarter because of one-time events. It's probably not reasonable to get too upset about the numbers Kellogg puts up in the back half of 2021. However, it has revamped its business and retained cereal as one of its core focuses. As 2022 gets underway, investors will want to keep a close eye on the division and whether it can improve.