Iconic food maker Kellogg (K 0.84%) has been working to shift its business toward growth-oriented niches, notably in the snack space. It completed a major business overhaul right as the coronavirus pandemic hit, obscuring the progress it has made.
That, however, isn't the only issue the company is facing today, as it also has to get its legacy cereal business back on track. And that's going to take some time.
The new and the old
When most people think of Kellogg, the first thing that comes to mind is probably cereals like Kellogg's Corn Flakes, Rice Krispies, and Raisin Bran. But the company also owns Pringles, Cheez-Its, Pop-Tarts, and MorningStar Farms. And it operates in emerging markets, selling a host of its core products and a selection of emerging market-specific offerings (notably noodles).
Image source: Getty Images.
This diversification is important for investors to understand. Putting a few numbers on this, snacks now make up a huge 40% of overall revenue. This is a sector that's increasingly important in the food space. Emerging markets account for 25% of the top line and are expected to be a strong growth driver over time as these regions move up the socioeconomic ladder. Frozen foods make up 10% and include nonmeat protein products, another hot sector. That leaves cereal at 25% of revenue, broken between international at 10% of revenue and North America at 15%.
The key takeaway is that while cereal is important, it is not Kellogg's growth engine. In fact, management isn't really looking for it to be a growth driver at all. It has been very clear that it doesn't need this division to be a growth business; it just needs the business to be stable over time.
That's not what it got in 2021.
More work to be done
Kellogg has been struggling to get cereal straightened out for a while, so this really isn't a new issue. It has been losing share to its largest competitor, General Mills, for years. And things got even worse in 2021 because of two company-specific headwinds.
First, there was a fire at one of Kellogg's cereal plants that disrupted production. And then the company was hit with an employee strike across the rest of its cereal plants that was even more disruptive. It simply couldn't supply its products to customers in a consistent way. It was pretty bad, with cereal sales off by 14.4% for all of 2021 and a huge 28.8% in the fourth quarter of the year.
The frozen foods segment was also a little weak, with full-year sales off 3%, the biggest issue there being that the company couldn't keep up with demand for new products. The snacks segment, meanwhile, was relatively strong, increasing full-year sales by 5.5%. So clearly, the problem child here remains cereal.
The good news is that Kellogg, according to management, just needs to stabilize the cereal business. The bad news is that management doesn't think it can do that until the second half of the year.
There are a few issues to consider. For example, because of the fire and strike, the company pulled back on advertising. It needs to get that spending back on track so its products are again on consumers' minds. That includes both in-store and other advertising formats.
On the production side, it needs to get its plants back up and running at full capacity. As long as the cereal plants are running below optimum levels, the company will lack operating leverage, and financial results will be weak. It will likely take at least until the end of the first quarter for Kellogg to get the plants operating the way it wants them to again.
But even that won't be enough to get the business back on track. This is because the company needs to rebuild inventory levels to ensure it has enough product to consistently supply its retail customers. That can't happen until the plants are fully operational. The process of getting inventory levels back up to snuff will probably last through at least the second quarter.
More cereal suffering
All in, it looks like roughly 25% of Kellogg's business will be working on a turnaround until at least the second half of the year. And that's just going to get the cereal business back to normal operations. After that point, it needs to take on the market share issue that's been going on for a few years now.
While this isn't good and needs to be monitored by investors, there's still 75% of the company that's doing comparatively better. The company's cereal troubles are hardly a death knell. In fact, for long-term dividend investors, the current headwinds could be an opportunity to buy an iconic food stock with a generous 3.5% dividend yield. Just make sure you go in knowing that the cereal business will be a headwind for at least another few months.
