It may not be obvious at first, but the latest earnings report from cereal giant Kellogg (NYSE:K) shows why Nelson Peltz may have the right prescription for what ails an investment in PepsiCo (NASDAQ:PEP).
Kellogg reported disappointing second-quarter earnings yesterday that saw the cereal maker cut revenue forecasts for the year, even though profits rose nearly 9% from the year-ago period. Growth opportunities are coming under pressure in the breakfast segment, as rivals like General Mills scramble for market share by cutting prices. Earlier this year, Post Holdings was similarly hurt by an increasingly promotional environment, and Kellogg's morning foods division saw sales fall 3.3% because of it.
Yet, there were two bright spots in its report: its Girl Scout cookies business (which also includes school and hospital food service) saw sales rise 8%, and its recently acquired Pringles snack business, where sales rose by a like amount. And that's where Pepsi could learn a thing or two.
While the cereal maker's snack business rose 8% overall, the Pringles line actually boosted sales 11%, underscoring the potential the division represents. When Kellogg acquired the potato chip maker from Procter & Gamble last year, it was catapulted to the No. 2 position in the snack foods industry behind Pepsi's Frito Lay division. Billionaire investor Peltz wants Pepsi to shed its beverage business and focus solely on snacks by acquiring international snack foods giant Mondolez.
The rationale behind the move is that beverages are stagnating, while snacks are growing. Peltz argues that as the perennial runner up to Coca-Cola, the beverage maker is suffering from declining volumes. Moreover, since Frito Lay already comprises two-thirds of Pepsi's revenues, enjoys top market share in several segments, and is experiencing volume growth, becoming a full-fledged snacks company makes the most sense.
Needless to say, management at Pepsi gave the idea the cold shoulder, and countered with the rather timid move of introducing a new premium bottled water.
While Kellogg is experiencing its own problems in its core breakfast business, the snack division now comprises a quarter of its revenues and a fifth of its operating profits. Much of the growth that Pringles generated was as a result of its international presence, which is why a Pepsi acquisition of Mondolez does have some cachet, even though it would cost a ton of money to do it.
Take Pringles out of the Kellogg picture, and you have a sagging cereal business. Remove beverages from a Pepsi investment, and you just might have a major growth stock on your hands.