Kellogg (K 1.05%) has been a standout performer so far in 2022, with the stock actually rising despite the bear market. While shareholders should be pleased, there are still fundamental business issues that need to be monitored. Inflation is a big one, and Kellogg just explained why it is so important to track.
Lots of noise
Companies don't operate in a vacuum, so there's always a reason for some companies to do better than others. In 2022, Kellogg's stock has risen an impressive 17% while the broader S&P 500 Index is down around 10%. Consumer staples, using Vanguard Consumer Staples ETF as a proxy, are down 2%, so Kellogg's stock is outdistancing not only the market but also its peer group.
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Some of that has to do with the stock's performance in 2021, which notably lagged its peers and the broader market. So to some extent, this is just a matter of playing catch-up. However, there is a reason for what's happening this year.
In 2021, Kellogg was dealing with company-specific headwinds, notably including a fire at a cereal plant and a strike in its cereal division that left it unable to fully satisfy demand for its products. Those problems are quickly fading, and the company's performance has benefited greatly. In addition, Kellogg recently announced plans to split itself up into three businesses. Essentially, it is keeping its largest growth-oriented operations and spinning off slower and smaller businesses. Investors, understandably, appear to like this idea.
But all is not perfect in Kellogg's business. And a key issue that still needs close monitoring is inflation.
Why inflation remains a problem
To be fair, there is usually a lag between inflation hitting and food makers like Kellogg actually passing through cost increases. It's just how the food business works, with companies having to accept a margin squeeze while they push price hikes through to consumers.
When Kellogg reported second-quarter earnings, it highlighted just how big a problem this has been. Although large price hikes have allowed it to increase its net sales per kilo of product sold in the low teens, its cost of goods per kilo of product sold has also increased in the high teens. The company noted "decades-high input costs" as a prime reason for the mismatch. To be clear, this isn't unique to Kellogg; all consumer staples companies are facing the same issue.
But that's also a negative, because some staples makers are starting to warn about consumer pushback on price hikes. For example, Procter & Gamble (PG 1.52%) recently said it was seeing a shift in buying behavior, despite the company's strong fiscal 2022 performance. P&G doesn't sell food, but it is a bellwether name in the consumer staples space; however, the warning can't be ignored given that Kellogg's products are, like those sold by P&G, higher-cost name-brand fare. It wouldn't be particularly difficult for consumers to buy store-brand frozen waffles over Eggos if they wanted to save some cash.
Be prepared for bad news
To be fair, Kellogg just increased its organic sales growth guidance for 2022, raising it from 4% to between 7% and 8%. It also increased its earnings guidance from up 1% to 2% to up 2%. This is good news, but notice the difference between those two changes. Organic sales basically double, but earnings move only to the high end of the previous guidance. Inflation is the issue on both sides of that equation, helping sales but limiting earnings.
If Kellogg finds it more difficult to pass cost increases on because of consumer pushback, you will likely see some negative earnings updates ahead. And that could quickly put a dent in the stock's relative outperformance.
