It's not often we get an inside look into what makes companies tick, which is why it's so important to pay attention to conference calls. The trick is to sort through all the fluff and zero in on the good stuff.
For Kellogg (NYSE:K), there were plenty of interesting tidbits buried in its call at the end of last month. CEO John Bryant did a nice a job of breaking down where the company is and where it's headed. Here are a few things he said that you should pay particular attention to.
1. Kellogg spends a lot on its brands
We already invest a significant $1.5 billion a year in brand building, an industry-leading level as a percentage of sales. And as you know, we intend to increase our investment in revenue-driving activities, including brand building and sales execution as part of the Project K initiative.
To put that number in perspective, Kellogg is a $23 billion company that does about $15 billion per year in sales and has about $1.1 billion in operating profit through its first two quarters of this year. So $1.5 billion (or 10% of sales) spent on brand building is a massive amount.
So it's very important that management spends that cash wisely. One way to tell if it's working is if the company is picking up market share. While Kellogg didn't disclose whether it did or didn't pick up share in the call, management did say that it invests more than 20% of its ad spend into digital properties and will continue to spend where it will get the most bang for its buck.
2. The consumer is evolving
While the category trends were not positive, we also faced some brand-specific issues. Special K continues to be affected by the evolving consumer trends affecting weight management brands in general. As a result, we are actively repositioning the brand and emphasizing the presence of positive nutrition like protein, fiber, grains, and other relevant nutritional benefits.
Unfortunately, it appears that Special K is not in the sweet spot for those looking to lose weight. Fortunately, Bryant is aware that increased protein is becoming a larger part of consumers' eating habits. Going forward, Kellogg should juggle its product portfolio to better meet its customers needs. So it will probably emphasize its high-protein offerings and de-emphasize the fun stuff like Froot Loops.
3. Project K found some opportunities
As you know, Project K is designed to ensure that we have the right capacity in the right locations to enable us to meet customer demand and market trends. As a result, we have made the difficult decision to close our London, Ontario, cereal plants and are in consultation to take production out of that plant in Manchester, U.K. Despite these actions, we may still have more capacity than we need in our cereal network. ... We remain on track to open the first regional center, which will support North America in the third quarter of this year, and we've announced our intention to open a center in Europe.
Project K is essentially a cost-cutting program; all the big food companies have their version. While painful for those working in the factories, the reallocation of assets is important for the health of these types of businesses. The impending regional center should help Kellogg down the line.
4. Kellogg has had some failed product innovation
So as you think about the business, we have distinct challenges with some valid innovation, with Special K and with Kashi, and we have plans for each. While Mini-Wheats has posted declines in consumption so far this year, the original bite-size version has performed relatively well. The overall decline has been largely due to innovation that hasn't worked, such as Mini-Wheats Crunch, but we're working through that impact. ... And we've also had an issue with some other failed innovation in Crunchy Nut and FiberPlus. In fact, the impact of these two brands accounts for the 0.5 point per-share decline in the quarter.
Failed product innovation happens to every company. Not everything works all the time. But you have to wonder why healthy cereals (like FiberPlus) are not catching on. According to the folks at General Mills, cereal is a top 10 food group, so the demand is there. The simple answer may have to do with taste. If a product doesn't taste good, it won't matter to the average consumer how healthy it is or how much money a company spends to promote it, it will not sell.
5. It's important to find the right person for the job
Kashi, which is one of the largest natural food businesses in the U.S., has not performed as well as we would have liked over the past few years. And while much of the recent decline is due to lower distribution, we need to address the brand's positioning and our ability to execute quickly enough in the evolving world of natural and organic foods. We haven't kept Kashi focused enough on progressive nutrition. And as a result, we have decided to make some dramatic changes. David Denholm, who ran Kashi very successfully in the 2000s, is returning to become CEO of the Kashi Company, which also includes the Bare Naked and Stretch Island Fruit snack businesses. This will be a largely autonomous business within the Kellogg family. Kashi will be based in La Jolla, where it began, and will be focused on returning the brand to the leading edge of the natural and organic food world. This business requires an entrepreneurial approach, shorter developed periods and a more agile decision-making process. And David is the right person to lead this significant change...
I'm a big fan of management; I think a good team can make all the difference. To me, bringing back Denholm and letting him run Kashi is a home run. By giving him the autonomy to run that business as he sees fit, upper management is right on point. Clearly, Denholm has done it before. This move could be huge for Kellogg.
Foolish final words
To sum up, Kellogg is having trouble with its product innovation and brands. But it spends a boatload of capital pushing its portfolio. So you would expect to see these things work themselves out. If they don't, and Kellogg loses market share, this could be an early sign of bigger problems.
The good news is its cost-cutting program is working and the company seems to be bringing back a gem to run Kashi in David Denholm. If you believe in the power of good management, you have to love this hire. Despite a few red flags, parts of the Kellogg business look promising.