Financial Statement Analysis of Kellogg Company

This document provides a comprehensive financial statement analysis of Kellogg Company, a leading producer of cereal and convenience foods. The analysis includes profitability ratios, liquidity ratios, solvency ratios, activity ratios, and market ratios. The document also offers recommendations for improving the company's financial performance.

FINANCIAL STATEMENT ANALYSIS
KELLOGG COMPANY
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Background
The company selected for this task is Kellogg’s which is one of the leading producers of
cereal and convenience foods in the world. The company was founded in 1906 and is
headquartered in Battle Creek, USA. The company is a listed entity with a market
capitalisation of about $ 20 billion. Even though the company has manufacturing facilities in
18 countries with sales of product in more than 80 countries but the major revenues for the
company (i.e. about 80%) is realised from the US and Europe market. The other key markets
are Latin America and Asia-Pacific. The operating segments of the company are divided both
on the basis of geography and the underlying food (Kellogg, 2017). A bulk of the revenue is
realised by the company from the sale of cereals where the company has faced issues in the
recent past owing to the altering customer trends especially in the US market (Zacks, 2018b).
The sales of the company have been languishing in the recent times owing to lacklustre
topline performance of the cereal division both in the US and Europe. This may be attributed
to the changing food preferences of the consumers who tend to demand more healthy options
in comparison to the traditional cereals (Peltz, 2016). Additionally, the consumers typically
have a significant amount of breakfast options to choose from and hence the cereal sales in
US have been in a downward trend for more than 5 years (CBS, 2018). As a result, more
innovation is required from leading manufacturers such as Kellogg so as to stabilise the
cereal sales at $ 10 billion annually in the US market. Also, owing to changing preferences,
Kellogg along with competitors are strengthening their product portfolios through the means
of acquisition. In this regards, Kellogg has completed the acquisition of Pringle and nutrition
bar RXBAR in 2017 (Zacks, 2018b).
The extent of competition in the convenience food industry and for Kelloggs is quite high. It
faces completion from General Mills, Kraft Heinz, Ingredion, J.M. Smucker, Nestle, Quaker
Oats to name the few. All these competitors tend to have product offerings that tend to
directly compete for market share with Kellogg. Besides, most of these players are
established players with well-known brands owing to which there is high competition in the
industry. This is clearly reflected in the recent sales trends for the Kellogg company as it is
not able to grab a higher market share in the US and Europe market. As a result, the focus of
Kellogg along with other players has been on product innovation through organic or
inorganic channels coupled with cost cutting so as to realise higher savings which can expand
margins and thereby boost earnings in the backdrop of tepid topline performance (Zacks,

2018a). Going forward, it would be imperative for Kellogg to derive a higher share of
revenue from international markets where the cereal market is expanding in contrary to US
and Europe.
Analysis and Discussion
Under the current market condition where cereal sales in the US as an industry are falling,
Kellogg has increased the focus towards enhancing savings through cost cutting measures
coupled with higher product innovation. Two noticeable cost savings measures which are
noteworthy are Project K and Zero Based Budgeting (ZBB). Project K , a four year cost
cutting initiative was launched in 2014 with the objective of supply chain optimisation
facilitated through facilities consolidation and excess capacity removal, productivity
improvement through common process consolidation besides leveraging product categories
with global focus. Till 2013, the project has led to savings in excess of $ 500 million and
nearly, the same amount would be realised in 2018 (Best, 2016). As part of this project, the
employee strength has been rationalised so as to ensure minimal process duplication (Watson,
2017). Also, ZBB initiated in 2016 had initiated a three year ZBB program to expand the
operating profit margins and the company has realised about $ 200 million increased profits
in both 2016 and 2017. The company is actively investing these savings into brand building,
project innovation and improving the sales capabilities (Kellogg, 2016). The key external
factor that is impacting the company and the cereal industry is the declining size as
preferences of the consumers are changing owing to which Kellogg also has witnessed
declining sales especially in the North America market, thereby leading to a stagnant top line.
The company also has focused on enhancing the product portfolio with more focus on high
nutrition convenience food (Zack, 2018a).
The financial performance of the company can be analysed using the ratio analysis over the
most recent five years from 2013 to 2017. This is carried out below.
Profitability Ratios
Profitability ratios tend to highlight the underlying profitability of the business activities
(Berk et. al., 2013). For Kellogg, the last five year profitability ratios are summarised in the
tabular manner indicated below (Kellogg, 2013; 2014; 2015;2016; 2017).

For all the profitability ratios, a common trend that is visible is that there is a sudden dip in all
the profitability ratios in 2014 compared to the corresponding ratios in 2013. However, from
2014 onwards to 2017, there has been improvement in all the profitability ratios with very
significant improvements in Return of Equity or ROE. The significant drop in profit margins
in 2014 may attributed to difficult trading environment where the sales suffered a decline
owing to which the gross profit margins were adversely impacted and dropped by about 600
basis points. Further, there were rise in operating costs owing to initiation of project K
coupled with higher distribution costs. The net result is that the decline operating profit
margin and net profit margin is more severe than the corresponding drop in the gross profit
margin. Owing to lower profits being generated by the company, the ROE and ROCE have
also suffered in 2014 as compared to the corresponding value in 2013.
Despite the dismal 2014, the company over the next three years has sprung back with regards
to profitability which is vital considering that sales for the company has marginally declined
and thereby the only means of enhancing the earnings is through margin expansion. This has
been realised through various initiatives such as Project K and ZBB which have already been
discussed above. On account of this, there is an improvement in the profitability ratios which
is expected to continue going forward to 2018 also. Owing to net profit improvement, the
ROA, ROE and ROCE have also improved between 2014-2017.
Liquidity Ratios
Liquidity ratios tend to highlight the ability of the company to meet the current or short term
obligations of the company or business. It is imperative that these should be healthy or else
the business would face short term credit crunch which would adversely impact the day to
day operations (Damodaran, 2015). For Kellogg, the last five year liquidity ratios are
summarised in the tabular manner indicated below (Kellogg, 2013; 2014; 2015;2016; 2017).

Based on the above liquidity ratios, it may be concluded that the overall trend during the
2013-2017 period has been downwards as the corresponding values of these ratios in 2017 is
lower than the corresponding value in 2013. This does not auger well for the business as any
further deterioration may lead to real threat of short term liquidity crisis.
Over the years, there has been significant increase in the accounts payables which has
increased from $ 1.43 billion at the end of 2013 to $ 2.27 billion at the end of 2017. From
2013 to 2014, there is no significant change in the liquidity rations but these have plummeted
in 2015 primarily on account of jump in current liabilities caused due to increase in current
portion of long term debt from $ 607 million at the end of 2014 to $ 1,266 million at the end
of 2015. In 2016, the current portion of long term debt again reached the 2014 levels and
hence there was an improvement in the liquidity ratios.
Solvency Ratios
The solvency ratios highlight the long term solvency and the ability of the company to meet
the long term debt obligations which essentially involve payment of interest on regular basis
coupled with long term debt repayment as per the underlying maturity period. Unhealthy
solvency ratios may lead to higher credit risk leading to increased financing cost coupled with
lack of availability of capital for the current and future expansion plans (Brealey, Myers and
Allen, 2014). For Kellogg, the last five year solvency ratios are summarised in the tabular
manner indicated below (Kellogg, 2013; 2014; 2015;2016; 2017).
It is apparent from the above ratios that there is a general deterioration of the solvency ratios
during 2013-2017. The debt ratio has consistently increased during the period with marginal

decline in 2017. This essentially highlights that the contribution of debt to the asset funding
has increased during the period which may be attributed to the decreasing in total
shareholders’ equity owing to which debt on the books is significantly higher in comparison
to the equity of the company. This is also reflected in the debt to equity which is
exceptionally high owing to the small and shrinking equity base of the company. On account
of lower profits being generated coupled with higher debt, the interest coverage ratio has
plummeted to 3.44 for 2016 from 12.07 for 2013. However, owing to recovery of operating
profits in 2017, there has been an improvement in the interest coverage ratio in 2017. Further,
the cash flow to debt ratio has also declined partly on account of rise in the overall debt on
the books of the company. Going forward, it makes sense for the company to be watchful of
any incremental debt considering the low equity base and prudent attempts at balance sheet
deleveraging must be undertaken.
Activity Ratios
The activity ratios provide an indication of the operational efficiency of the business
operations of the company. In this regards, the objective of the company should be to shorten
the cash conversion cycle by ensuring faster conversion of inventory to sales and credit sales
to cash while ensuring a longer creditor payment period. Additionally, it is expected that
higher efficiency would be exhibited with regards to deriving sales from the use of
company’s assets (Christensen et. al., 2013). For Kellogg, the last five year activity ratios are
summarised in the tabular manner indicated below (Kellogg, 2013; 2014; 2015;2016; 2017).
Based on the above ratios, it is apparent that there has been an improvement in the overall
working capital management on part of the company during 2013-2017. This is apparent
from the fact that cash conversion cycle has constantly improved as it has become shorter and
infact in 2017, it has become negative which enables the company to limit the working
capital requirements. However, this improvement has been received only on account of
increase in creditor collection period from 2 month in 2013 to about 3.5 months in 2017.
There has not been any improvement in the inventory turnover period and debtor collection

period which have marginally increased which is indicative of higher time required to convert
inventory into sales and also collecting cash from credit sales. The asset turnover over the
years has also declined which may be attributed primarily to the lacklustre performance of the
cereal division which has witnessed continuous fall in sales especially in US.
Market Ratios
From an investment perspective, market ratios are pivotal as it highlights whether the stock is
overvalued or undervalued. Besides, the dividends yield is also reflected which is pivotal for
an established company with a mature business (Brigham and Houston, 2014). For Kellogg,
the last five year market ratios are summarised in the tabular manner indicated below
(Kellogg, 2013; 2014; 2015;2016; 2017).
It is apparent that the EPS of the company has significantly dipped in 2014 in comparison to
2013 owing to lower revenues, higher distribution costs and cost of Project K initiative. The
company has been able to cover the EPS especially in 2016 and 2017. The P/E ratio of the
company has been quite variable which is mainly on account of the corresponding changes in
EPS rather than the price. The price of the company has been caught in a narrow range for the
past five years owing to concerns about the topline growth that continue to haunt investors.
However, over the years, there has been marginal improvement in the dividend yield which
for 2017 exceeds 3%. This consistent and sizable dividend yield is positive from the
investors’ perspective.
Conclusion & Recommendations
Based on the above analysis, it is apparent that the company on account of cost cutting
initiatives initiated in 2014 has been able to improve the profitability performance over 2014-
2017 after the dip in 2014. Further, with regards to liquidity ratios, where there has been a
general decline in the ratios, it does not currently pose any short term liquidity threat. With
regards to solvency ratios, the balance sheet seems to be over-leveraged owing to small
equity base and hence with regards to future funding of projects, the company ought to be
cautious in assuming more debt. With regards to cash conversion cycle, the company has

seen improvements during 2013-2017 but it has arisen only from the increasing payable
period. Further, the asset turnover has declined owing to lacklustre sales performance during
the period. The market ratios indicate a stable dividend yield coupled with concerns of
investors with regards to future concerns.
The current business landscape seems to be highly competitive crippled with changing
consumer preferences in the breakfast cereal market. As a result, the company needs to
increase its revenues contribution from emerging markets in Latin America and Asia-Pacific.
Besides, product innovation and embracing the changing consumer preferences would be
crucial going forward while reaping the savings from Project K and ZBB. A key limitation of
this analysis is that it is essentially based on historical data which may not be applicable in
the future. Also, the ratio analysis is highly driven by the corresponding accuracy of the
financial statements and any lapses in this regards could have adverse impact on the analysis
conducted as part of this report.

References
Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V. and Finch, N. (2013) Fundamentals
of corporate finance, London: Pearson Higher Education
Best, D. (2016), Kellogg on new targets, zero- based budgeting, managing revenue and Q2
results – 5 Things to learn, [online] Available at:
https://www.just-food.com/analysis/kellogg-on-new-targets-zero-based-budgeting-managing-
revenue-and-q2-results-5-things-to-learn_id134042.aspx [Assessed December 29, 2018]
Brealey, R. A., Myers, S. C. and Allen, F. (2014) Principles of corporate finance, 2nd ed.
New York: McGraw-Hill Inc.
Brigham, E. F. and Houston, J. F., (2014). .Fundamentals of Financial Management, 4th ed.
Boston: Cengage Learning.
CBS (2018), Cereal sales slump amid changing diets and other breakfast option, [online]
Available at: https://www.cbsnews.com/news/cereal-sales-declining-changing-nutrition-
other-options/ [Assessed December 29, 2018]
Christensen, M, Drew, M, Blanchi, R . and Ross, S. (2013), Fundamentals of Corporate
Finance, 6th ed., New York: McGraw Hill
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York:
Wiley, John & Sons.
Kellogg’s (2014), Kellogg Company 2013 Annual Report, [online] Available at:
http://www.annualreports.com/HostedData/AnnualReportArchive/k/NYSE_K_2013.pdf
[Assessed December 29, 2018]
Kellogg’s (2015), Kellogg Company 2014 Annual Report, [online] Available at:
http://www.annualreports.com/HostedData/AnnualReportArchive/k/NYSE_K_2014.pdf
[Assessed December 29, 2018]
Kellogg’s (2016), Kellogg Company 2015 Annual Report, [online] Available at:
http://www.annualreports.com/HostedData/AnnualReportArchive/k/NYSE_K_2015.pdf
[Assessed December 29, 2018]

Kellogg’s (2017), Kellogg Company 2016 Annual Report, [online] Available at:
http://www.annualreports.com/HostedData/AnnualReportArchive/k/NYSE_K_2016.PDF
[Assessed December 29, 2018]
Kellogg’s (2018), Kellogg Company 2017 Annual Report, [online] Available at:
http://www.annualreports.com/HostedData/AnnualReports/PDF/NYSE_K_2017.pdf
[Assessed December 29, 2018]
Peltz, J. (2016), Why Americans are eating less cold cereal for breakfast, [online] Available
at: https://www.latimes.com/business/la-fi-agenda-breakfast-cereals-20161010-snap-
story.html [Assessed December 29, 2018]
Watson, E. (2017), Kellogg to slash 7% of global workforce in cost- cutting ‘Project K’,
[online] Available at: https://www.foodnavigator-usa.com/Article/2013/11/04/Kellogg-to-
slash-7-of-global-workforce-in-Project-K [Assessed December 29, 2018]
Zacks, (2018 a), Kellogg (K) Gains From Cost Saving Initiatives, Sales Weak, [online]
Available at: https://www.nasdaq.com/article/kellogg-k-gains-from-cost-saving-initiatives-
sales-weak-cm931975 [Assessed December 29, 2018]
Zacks, (2018 b), Can Kellogg’s Strategic Initiatives Offset Cereal Unit Woes?, [online]
Available at: https://www.zacks.com/stock/news/329234/can-kelloggs-strategic-initiatives-
offset-cereal-unit-woes [Assessed December 29, 2018]