Kellogg's Earnings Aren't So Great!!

Kellogg (NYSE: K) reported third quarter earnings this morning that missed estimates. It also guided 2011 earnings lower. There is nothing "Special" about this "K" quarter or outlook.

The Battle Creek, MI-based company reported earnings of 80 cents per share on $3.31 billion in revenues. Wall Street was looking for 89 cents per share on $3.41 billion in revenues.

In addition, Kellogg said that it now expects earnings for 2011 to be $3.27-$3.33 per share. This is sharply lower than the $3.33-$3.40 per share that Wall Street is expecting, and that is the reason shares are plunging today, down some 7%.

"We are continuing to rebuild our momentum as a company. The third quarter offered some compelling signs of improvement, particularly top-line growth and in-market performance. Rebuilding momentum takes time, especially in challenging market environments. We increased the levels of investment in our supply chain in the quarter, a process we will continue. This multi-year program will improve the infrastructure and drive reliability and capability," said John Bryant, Kellogg Company's president and chief executive officer.

The company also offered a look at what it expects in 2012. It said it expects internal net sales to grow by 4 to 5 percent, and earnings per share are anticipated to grow 2 to 4 percent. This included the $2.5 billion share buyback program the company has for three-years.

Bryant went on to say, "We're making progress in 2011 by strengthening our innovation pipeline and investing in our supply chain. We expect this progress to continue throughout 2012 as we work to invest further in our ability to deliver dependable growth. As always, we are firmly committed to running the business for the long term and will continue to invest in our business in 2012; we believe this is the best way to ensure sustainable momentum."

The company has too much exposure to North America, where it has been incredibly hard to pass along pricing powers. As corn, wheat, cocoa and other commodity costs rise, Kellogg has been unable to share the burden with consumers, who are still incredibly price sensitive.

Consumers do appear likely to switch to private label brands if they feel like Kellogg's, Keebler, Cheez-It, Murray, Austin, and Famous Amos brands are not becoming good values for their purchasing dollars.

There has not been much differentiation and developments in the company's main products, and many feel the brands are getting stale or old. The comapny did say it is continuing to make investments, but that is going to hit earnings in the short term.

If commodity costs continue to rise, and there is a chance they will with the increasingly likelihood of a third round of quantitative easing, Kellogg could see some serious margin erosion. Operating margins are 16.06%, and operating profit declined 9 percent internationally, and 12 percent in North America.

Shares trade at 12 times expected 2012 earnings, and sport a 3.2% dividend yield. While the dividend is in no danger of being cut anytime soon, earnings could continue to decline if commodity prices continue to jump.

Tony the Tiger may have said "They're Great!!!!!" about Frosted Flakes, but the same can not be said for Kellogg, at least this quarter.

ACTION ITEMS:

Bullish:
Traders who believe that Kellogg will be able to pass on price increases might want to consider the following trades:

• If the company can pass off price increases, this could be good for names like ConAgra (NYSE: CAG), Procter & Gamble (NYSE: PG), and General Mills (NYSE: GIS). Traders may consider going long these names.

Bearish:
Traders who believe that price increases can not be passed on may consider alternate positions:

• Super markets, and stores like Target (NYSE: TGT) and Wal-mart (NYSE: WMT) are always looking for ways to deliver value to customers. If customers will not take the price increases, market share for companies like Kellogg and General Mills could be cut, and this could help Targets' brand, as well as Wal-Mart's brand.
  
  

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