Despite working the Keebler elves harder than ever -- selling some $2.58 billion worth of cereals and snacks in the fourth quarter -- breakfast king Kellogg (NYSE:K) could not overcome higher corn and wheat prices, and thus saw profits fall by 5% from last year.
North American sales account for two-thirds of all of Kellogg's annual revenues, and that segment saw healthy 7% growth, but fourth-quarter breakfast cereal sales dropped 2% after having posted strong 8% increases in 2005. The rest of its food categories, which are really wide and varied and include everything from cookies and snacks to waffles and Kashi brand health foods, saw sustained strength in the quarter. In particular, the retail snacks segment grew by 11% on the year when the effects of currency exchange rates, acquisition costs, and other factors were removed. Internationally, Kellogg saw 6% growth across all channels.
Despite the positive results in sales, higher corn prices plagued the expense side, causing costs to rise by 8.5% over last year. Couple that with a 10% increase in selling and administrative costs (due to stock options and business investment costs), and operating profits ended up flat. You can see the specifics in my Fool by Numbers article.
Kellogg was happy with its performance and raised guidance for the year by a penny, forecasting its earnings for somewhere between $2.68 and $2.72 per share. It also foresaw a 4% increase in sales, which suggests that revenues could be as much as $11.3 billion in 2007. The cereal maker said those forecasts include significantly higher commodity costs, like higher corn prices and increased advertising costs, as it continues to build brand awareness. Guess we'll be seeing a lot of more the elves and Tony the Tiger.
Ever since President Bush mentioned ethanol in his 2005 State of the Union speech, corn prices have been on a meteoric rise. A 56-pound bushel of corn has risen 115% from $1.86 at the end of 2005 to $4 a bushel today. The president's call for a fourfold increase in the use of alternative fuels has the markets in a frenzy over prices, but it's more than just ethanol; pork and poultry producers are also fighting for corn to feed their livestock.
Interestingly, as the mandate for alternative fuels has pushed corn prices higher, ethanol producers may actually suffer as well, with the price of a gallon of gas at around $2 per gallon. It's just not as cost-effective to produce when prices are so high.
Also being swept up in the ethanol mania are wheat prices, which were up about 25% in 2006. Futures contracts for December are showing another 22% increase, to around $5.50 a bushel. It's not without good reason that Kellogg is expecting significant increases in commodity costs this year.
Undoubtedly, consumers will feel the pinch as Kellogg, General Mills (NYSE:GIS), and Kraft (NYSE:KFT) have to raise prices to compensate for their higher costs. But they can only go so high before sales drop off even more, and cereal has already taken a small hit at the cereal maker.
Expect that Kellogg will continue to show the same steady performance it's been known for, but look for higher commodity costs to continue eating away at margins.
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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
