Kellogg 3rd-quarter net income falls; outlook cut

By Mae Anderson

AP Business Writer

NEW YORK (AP) -- Cereal and snack maker Kellogg Co. last week said its third-quarter net income fell 14 percent, worse than expected, as the company spent more on improving its supply chain, adding to cost pressure it already faces from soaring commodity costs.

The world's largest cereal maker also lowered its earnings guidance below expectations. Company shares fell nearly 8 percent in midday trading.

Kellogg, like most food makers, has raised prices to offset rising costs for ingredients and fuel, trying to find the tricky balance between how much prices can increase before consumers forgo brand-name loyalty and opt for low-priced rivals. So the supply-chain costs were added pressure for the food maker, which makes Frosted Flakes, Keebler cookies and Eggo waffles.

But Kellogg said it became apparent the additional supply-chain investment is necessary to ensure food safety at its plants, which have faced several health scares over the past few years. Earlier this year, the Food and Drug Administration found traces of listeria at its bakery in Augusta, Ga., during an inspection. That followed a major cereal recall last year and problems at another plant that led to a shortage of Eggos.

At the Augusta plant, the company reduced volume and renovated the plant to improve safety. That spurred the wider investment spending, he added.

"We sat back and looked at Augusta, got to the root causes within the Augusta facility, and took the lessons learned, fixed Augusta and took it across our broader network," said CEO John Bryant.

Across the supply chain, the company is improving plants' layouts, adding staff, expanding training and development programs, changing suppliers and increasing independent testing and auditing, Bryant said.

Still, some analysts complained that Kellogg should have discussed the increase in costs earlier.

"These costs should not have been a surprise, in our view, and we wonder how that could have happened," said Citi Investment Research analyst David Driscoll.

Another analyst expressed more distress.

"It seems like the more rocks that are turned over, there's more ugly stuff underneath," said Deutsche Bank analyst Erik Katzman of Deutsche Bank during a call with management. "And it's amazing that a company like Kellogg with its reputation is actually going through this."

The problems stemmed from cutting its U.S. workforce too much during a restructuring program aimed at cutting costs, and overworking its plants and other assets, Bryant said during a call with analysts. He said the company is now trying to head off problems before they happen, rather than reacting to them.

Volume fell 1.9 percent during the quarter, but Kellogg said that was expected due to price increases.

Net income fell to $290 million, or 80 cents per share, in the three months ended Oct. 1. That compares with $338 million, or 90 cents per share, last year. Analysts expected 89 cents per share, according to a poll by FactSet.

Revenue rose 5 percent to $3.31 billion, from $3.16 billion last year. Analysts expected $3.41 billion.

In North America revenue rose 4 percent to $2.2 billion. Sales of cereal were flat, which the company blamed on fluctuation in trade inventory. Snack sales rose 3 percent on demand for crackers and cookies. Frozen food sales were also strong.

Internationally, revenue rose 7 percent to $1.1 billion, boosted by the weaker dollar. Results in Latin America were strong and Europe continued to improve.

Kellogg said it continues to expect revenue will grow 4 percent to 5 percent in 2011, but it lowered its net income guidance because of continued investment in its supply chain. It now expects net income of $3.35 to $3.41 per share, from prior guidance of $3.42 and $3.49 per share. Analysts expect $3.48 per share.

In 2012 the company also expects revenue to rise 4 percent to 5 percent with net income, excluding currency fluctuation, up 2 percent to 4 percent.

Published: Mon, Nov 7, 2011


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