Is Kellogg Doomed?

Kellogg (NYSE: KR) seems to be a very desperate company these days. The iconic cereal maker is launching a new marketing campaign directed at the only people perceived to still buy its products: lame or clueless dads.

The company has even hired Alfonso Ribeiro; the actor who played Will Smith’s dorky cousin on the cheesy 90s sitcom The Fresh Prince of Bellaire, to serve as a spokesman, the Grub Street blog reported. Ribeiro will serve as the centerpiece of a marketing campaign aimed at middle-aged men.

The idea is apparently to whip up nostalgia for those halcyon days of the 70s and 80s; when kids ate their favorite cereal while watching Saturday morning cartoons. Kellogg apparently hopes that getting dad nostalgic about cereal, will somehow get kids to start eating it.

This marketing campaign seems like an act of desperation that’s likely to fail. After all it is hard to imagine today’s kids trading yogurt for cereal; or today’s moms feeding their kids a bowl of sugar coated mush. My guess is nostalgia will end the moment, mom sees how much sugar Frosted Flakes contain.

Is Kellogg a Doomed Company?

It is easy to see why Kellogg is taking such desperate measures the company’s revenues are in what looks like an irreversible death spiral. They only seem to be heading in one direction: straight down.

Back in June 2013, Kellogg reported revenues of $14.86 billion, those revenues fell to $14.64 billion in June 2014, $14.21 billion in June 2015 and $13.13 billion in June 2016. Not only are revenues falling the revenue loss seems to be accelerating.

Between second quarter 2013 and second quarter 2014, Kellogg’s revenues declined by $220 million. The revenue drop grew to $430 million over the next year and to $1.08 billion for the fiscal year that ended on June 30, 2016.

Kellogg’s is facing a very serious problem, the revenue shortfall indicates a serious drop in sales. One has to wonder how long the company can continue with its presence business model while losing around $1 billion a year.

Kellogg is Making Money

Despite its revenue drop Kellogg is still making money. The company reported a net income of $1.74 billion, a profit margin of 8.57%, a free cash flow of $538 million, assets of $15.39 billion, cash and short-term investments of $531 million and $1.758 billion cash from operations on June 30, 2016.

That indicates a business model that is fundamentally sound but for how much longer. The net income fell from $1.845 billion in June 2014 to $381 million in June 2015 but picked up again to $619 million in June 2016. Cash from operations is also up; Kellogg reported $1.756 billion in cash from operations in June 2014 that fell slightly to $1.72 billion in June 2015 and rose to $1.758 billion in June 2016.

This shows us that Kellogg still has quite a bit of float it looks like a really good consumer products company that sells a profitable product. The market is shrinking but there’s a lot of money in it.

Investors were certainly pleased with Kellogg’s performance they received a return on equity of 27%, and a dividend yield of 2.62% on September 16, 2016. They also took home a cash dividend of 52¢ on August 30, 2016.

Kellogg is a pretty good company in a shrinking business. It is well run and proving my theory that a strong company can boost weak brands and weak products. The problem is that the products are not selling like they used to.

Does Kellogg have a Future?

Kellogg faces three serious but not insurmountable problems with its products. The most obvious of these; which we already touched upon, are health concerns and changing tastes.

Americans simply are not eating breakfast cereals like they once did. Many Millennials seem to prefer Egg McMuffins, breakfast burritos, Starbucks pastries or microwaved waffles to cereal, quite a few people skip breakfast entirely and lots of people view cereal as unhealthy. Certainly health concerns about diabetes, metabolic syndrome and the constant drum beat the dangers of sugar pouring out of the media and some doctors have scared Americans away from cereal.

Sugar has been found to be a risk factor for heart disease, diabetes and other serious health problems. There is a growing school of doctors that even point out eggs are actually good for you while sugar coated cereal is bad.

Such health concerns may end up trumping Kellogg’s nostalgia campaign. Mom not wanting the kids to get diabetes is likely to pitch dad’s Frosted Flakes straight into the garbage can.

How Private Label is Killing Kellogg

A third problem; and one Grub Street ignores, is the growing promotion of private label or house brands by big retailers. Companies like Safeway, Kroger (NYSE: KR), Aldi, Trader Joe’s, Walmart (NYSE: WMT), Costco (NASDAQ: COST) and even Amazon (NASDAQ: AMZN), all offer private-label cereals that are comparable to Kellogg products. These products are usually cheaper and they are easy to market to the growing number of Americans with little or no sentimental attachment to older brands.

Big retailers like private-label because it gives them more control over their marketing efforts. They can set the price and offer special deals to lure customers in. Kroger in particular likes to use its private label products as loss leaders to drive foot traffic.

A related problem is the decline of traditional media which buoyed traditional brands by keeping them in the public eye through advertising. Now we have a growing number of Americans that never see Kellogg’s advertising because they watch all their television via streaming video.

Tony the Tiger is no longer effective advertising because large numbers of Americans never see him. There’s now a whole generation of kids that has never watched cartoons on Saturday morning which means they’ve never seen Kellogg’s ads.

Can Kellogg Survive?

Kellogg might survive these developments if it reinvents itself, perhaps by offering exclusive private label variants of its well-known brands that are available through certain retailers. This might work with Amazon, Costco or Amazon’s Jet.

It would also have to develop new marketing techniques perhaps by taking advantage of online ads or streaming video. Funny YouTube videos featuring Alfonso Ribeiro might develop a cult following, although their effectiveness as advertising is debatable. Targeted ads offering discounts to soccer moms might be a better strategy. General Mills (NYSE: GIS) is already doing that with Cheerios.

All this makes Kellogg a good short term investment but not a good long term stock. It will make money for the next few years but future prospects are doubtful. My prediction is that Kellogg will end up as part of larger organization such as Berkshire Hathaway (NYSE: BRK.B) or even a retailer like Kroger (NYSE: KR) at some point.