Kellogg's (K -1.23%) first-quarter 2022 earnings were tough to read. That's not because they were inherently bad, but because there were a lot of moving parts that investors needed to digest. In some ways the company's performance looked weak, but in others it was doing quite well. Overall, Kellogg is probably doing better than what its earnings suggest. Here's why.
The big picture
Kellogg, an iconic food maker, was able to increase organic sales by 2.4% in the first quarter. However, almost all of that gain came from the company increasing prices, which was a 9.9 percentage point benefit. Offsetting that were currency fluctuations, which are out of the company's control, and volume declines. On the surface, it looks like Kellogg jacked prices up a lot and, at the same time, lost a lot of customers.
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That's not exactly a good outcome. The negative highlight here would be the company's North American business, in which organic sales growth not only declined year over year -- it actually fell into negative territory, dropping 1%. North America makes up more than half of Kellogg's business, so this is a very big deal.
That said, there were also issues on the mix front, with Kellogg, overall, seeing sales of lower-priced items increase at the expense of higher price fare. That, too, sounds bad, as this generally leads to margin compression, which was evident in the quarter. So while the organic sales number rose, it looked kind of like an ugly quarter just the same. Or was it?
A deeper dive
Nothing happens in a vacuum, so you have to add some context to understand the weak showing in Kellogg's North American business. Late in 2021, the company was faced with a strike at all of its cereal factories, and one of those factories was shut down because of a fire. The company is still working its way back from the effects of these events and, in fact, won't be back up to full speed in the cereal division until perhaps the second half of the year.
When management spoke about the first quarter, it noted that the volume decline in cereal accounted for about half of the overall volume decline for the company. Only this volume drop had nothing to do with price increases or mix; it was because products simply weren't available to be sold. As cereal production recovers, this should be less and less of an issue. In fact, if you exclude cereal, the company reports that its North American business saw a sales gain of as much as 3%. That's a much better number.
As for mix, the big issue isn't actually that customers are trading down. The "problem" is that the company's business in emerging markets is growing. Products in these markets cost less, so it affects the company's mix. But growing rapidly in emerging markets is a key long-term target and one that actually helps the business expand. Indeed, increasing sales in emerging markets doesn't end up cannibalizing the company's other products in any way because they aren't in direct competition. It just grows the overall business. That is a good thing.
Look at the whole story
Kellogg's first quarter was filled with moving parts that need more than a cursory thought to understand. It looks like this food maker is doing pretty well, all things considered. And once the North American cereal business has recovered from last year's pain points, things will start to look much better. However, it is important to note that cereal isn't expected to be a growth engine (stability is the goal). That's up to the company's other businesses, including snacks (which had a fine quarter) and emerging markets.
