Kellogg Third-Quarter Profit Declines 14% as Costs Increase

Kellogg Co., the maker of Corn Flakes cereal and Keebler cookies, said third-quarter profit fell 14 percent as it boosted spending to upgrade factories and monitor suppliers more closely. The shares fell the most in three years.

Net income declined to $290 million, or 80 cents a share, from $338 million, or 90 cents, a year earlier, Battle Creek, Michigan-based Kellogg said today in a statement. The average estimate of 20 analysts surveyed by Bloomberg was for 89 cents.

Chief Executive Officer John Bryant said Kellogg will spend an additional $70 million this year to hire about 300 U.S. plant workers and improve quality controls after recalls and factory shutdowns in the past two years. Kellogg’s cost of goods sold rose 9.7 percent to $1.96 billion because of the investments and reinstated incentive payments.

“I am very surprised and disappointed,” David Kolpak, who helps oversee $29.1 billion, including Kellogg shares, at Cleveland-based Victory Capital Management, said in an interview. “It’s becoming clear that they have underinvested in the infrastructure of the company for some time. Now that underinvestment is coming back to bite them.”

Kellogg tumbled 7.6 percent to $49.91 at the close in New York, the biggest decline since November 2008. The shares have fallen 2.3 percent this year.

Forecast Cut

The company also cut its full-year forecast for earnings per share to as much as $3.33 from a previous projection of a maximum of $3.40. Analysts estimated $3.48. For 2012, the company said it expects earnings per share to rise 2 percent to 4 percent, excluding the effect of currency fluctuations. Kellogg previously had forecast long-term growth of 7 percent to 9 percent, Alexia Howard, an analyst at Sanford C. Bernstein & Co. in New York, said today in a note.

“I know they want to reinvest heavily, but this is much more aggressive than I expected,” Christopher Growe, an analyst at Stifel Nicolaus & Co., said in an interview. The St. Louis-based analyst recommends buying the shares.

Bryant said on a conference call with analysts that a 2009 cost-reduction program “cut too deep” in the U.S. and the company is now adding back employees, increasing factory capacity and improving food quality controls and supplier audits. Bryant was the company’s U.S. chief in 2009.

“We were chasing aggressive productivity goals,” Bryant said in an interview. “We thought we were making sustainable cost reductions, but they were not. We are disappointed, and we are now investing what is appropriate to invest, not just what we can afford to invest.”

Lose Patience

The additional factory spending, recalls, plant closings and reduced profit forecasts of the past two years may cause investors to lose patience, Kolpak said.

“I thought this was a company that consistently managed its business for the long term, but apparently they have made decisions for the short term that are coming back to haunt them,” he said. “At some point investors say, ’Boy, who has a handle on the operations of this company?’”

Third-quarter sales rose 4.9 percent to $3.31 billion. The average estimate of 17 analysts was $3.41 billion. North American cereal sales were little changed in the quarter. International sales increased 2 percent, excluding the impact of currency, fueled by Latin America.

‘Step Back’

“Reported revenues were slightly light of our expectations, but it sounds like some of it could be timing of shipments to retailers,” Matt Arnold, an analyst at Edward Jones & Co., said in an e-mail. “Turnarounds are rarely in a straight line, and we view these results as a step back in a long-term upward trend.” The Des Peres, Missouri-based analyst recommends buying the shares.

Bryant didn’t say how long the factory-related spending would continue.

“Supply-chain problems take a long time to fix,” Robert Moskow, an analyst at Credit Suisse AG in New York, said in a note to clients today. “It is unclear how long it will take for these investments to get Kellogg’s operational effectiveness back to normal.”

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