K - Kellogg: Sales Volumes Hold Up And Guidance Improves

2023-05-06 07:56:35 ET

Summary

• Sales volumes drop less than expected.
• Prices have risen sharply due to rising input costs.
• Supply chain-related problems due to lockdowns during the pandemic are decreasing day by day.

Once again, analysts' estimates were beaten and Kellogg (K) surprised on both EPS and revenues.

Overall, there was no major news in this Q1 , except for that concerning elasticity. Management was pleasantly surprised at how overall sales volumes did not decline that much compared to price increases. The only underwhelming results concerned volumes in Europe and Latin America: the former remains a very competitive market, while the latter is subject to a rather complex macroeconomic and geopolitical environment. Finally, guidance has been revised upward, a sign of confidence that is pleasing to shareholders.

Comment on Q1 2023

Net revenues increased 10.40% over Q1 2022, but organic growth was 13.70%. This difference depended on a still too strong dollar.

However, this growth was more than offset by rising non-recurring expenses, which actually worsened operating income by 14.90% compared to last year's quarter. This is what I am referring to:

• A negative mark-to-market impact swing of $57 million.
• Incremental upfront costs related to the ongoing separation of $51 million.

Since these are not considered recurring expenses, the company also calculated what operating income would have been without them and without the unfavorable fluctuations in the exchange rate: in this case operating income would have been $560 million, a 17.70% increase over last year's quarter. In short, the Non-GAAP figure shows a whole different story than the GAAP figure.

Anyway, these are not the only expenses that have increased.

COGS and SG&A went from $3.15 billion in Q1 2022 to $3.61 billion in Q1 2023, an increase of $460 million.

The reasons for this increase are always the usual ones, namely inflation and supply chain, but it seems that at least the situation is gradually returning toward normalcy. Regarding the first problem, mid-teens inflation is expected at least for this year, as it still has a major weight on input costs. Regarding the second problem, Steven Cahillane ((CEO)) is more optimistic:

We still have the odd shortages, inventory not being in the right place from some of our suppliers. But I mean literally, every day, it's getting better. We're not back to just-in-time inventories. We're not back to where we were. I don't think anybody is. But we're much closer and the outlook going forward continues to be one - definitely much more of optimism than what we saw up to this point. In the second half of the year, we see continued improvement.

Overall, Kellogg was able to manage both problems as well as possible this quarter; in fact, margins were not affected.

• Currency-Neutral Adjusted Gross Margin was 31% while in last year's quarter 30.40%.
• Currency-Neutral Adjusted Operating Profit was 13.81% while in last year's quarter 12.96%.

The achievement of this result was possible mainly due to the sharp increase in prices, which, however, on the other hand, resulted in a decrease in sales volumes.

As we can see from this table, pricing had a major impact on net sales growth, in fact Kellogg's product prices increased by 15.60% against a 1.90% reduction in sales volume. Not too much actually, in fact even management was pleasantly surprised by this result:

Price mix growth was sustained in the mid-teens, reflecting revenue growth management initiatives around the world, which we implemented during 2022 and right through quarter one 2023 as we continue to work to offset high input cost inflation. Volume declined reflecting price elasticity, though not as much as we had expected for quarter one.

Undoubtedly, Latin America (-7.50%) and Europe (-5.90%) suffered the most in terms of volume:

The former because the company has been facing new macroeconomic and geopolitical challenges for about 2 years; also, exchange rate volatility does not help. Elasticity is increasing, but then again, management expected this. Price increases in this area are very high to overcome input cost inflation.

However, it is a different discussion for Europe, which is defined as a difficult environment to operate. Certainly, no longer being able to operate in Russia is not good for Kellogg's coffers, but this is not the only reason why sales volumes have suffered a major setback. With prices rising sharply, customer behavior is changing in favor of hard discounters. Despite this, the company does not seem particularly concerned.

It is likely that prices will continue to rise, as the company is trying to protect its margins from inflation as much as possible, and in my opinion it is right to continue in this vein: looking at the overall picture, the reduction in volume has been low compared to the increase in prices. In any case, it depends a lot on future inflation levels, which the company cannot control of course. If inflation continues to impact input costs, we can expect further rises.

Finally, I conclude this comment on the quarterly report with the guidance for FY 2023.

Except for free cash flow, the guidance has been revised upward. After the Q1 results, the company is more confident about the rest of the year.

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