2006 Processor of the Year: Kellogg — The original health food company

Kellogg Co. may be the original health food company. Most people know the story of the company’s founding. While just about every food processor is pursuing healthy foods now, Kellogg was established with a focus on health and wellness, and today remains a leader by delivering health through cereals – including organic cereals under the Kashi and now Kellogg brands – as well as soy foods, cereal bars, fruit leather and, just recently, protein-infused water.

Kellogg is on trend for plenty of other reasons: convenient and on-the-go products such as Eggo waffles, Pop-Tarts and other toaster pastries; crackers and other baked snacks from Keebler that have removed trans fats; and a global presence that dates back to the 1920s, long before most American food firms dared to tread overseas.

Besides being trendy, Kellogg has turned in five consecutive years of increased revenues and earnings per share; gained share in the hotly competitive U.S. ready-to-eat (RTE) cereal market for six years; and held or gained category share in nine of the company’s 10 focus businesses outside of the U.S. “This broad-based growth gives us confidence for the future and proves the viability of our strategy, operating principles and business model,” says Chairman James Jenness.

With a long history of product innovation, manufacturing prowess that runs 46 plants in 17 countries and a series of visionary managers — one of whom was spirited away to become U.S. secretary of commerce — we are proud to name Kellogg our Processor of the Year. The fact this honor comes at the conclusion of the company’s 100th anniversary year is just icing on the Kellogg cake.

Audacious Keebler acquisition

“Your selection of Kellogg as Processor of the Year is overdue,” says Christopher Growe, food and beverage analyst with A.G. Edwards & Sons Inc., St. Louis. “Kellogg’s emergence as a top-tier food company began six years ago and today’s robust growth profile is evidence of the truly strong category exposure and diligent management of this company.”

A transformational moment for the company came in early 2001, when Kellogg made the biggest acquisition in its history, paying a whopping $4.56 billion for Keebler Foods Co. Overnight, Kellogg grew from a $6 billion mostly-cereal company to an $8 billion company that was immediately No. 2 in cookies and crackers. Like most acquisitions, there were challenges, as Kellogg worked to integrate Keebler into its own culture. However, the acquisition in retrospect is considered by analysts as one of the smoothest consolidations among the many that took place in the food industry at that time.

“The acquisition of the Keebler Co. added new categories to our portfolio, further broadening our business beyond our core breakfast focus,” says Jeff Montie, executive vice president-North America. “Today, our snacks business is one of the pillars in the company’s proven, focused strategy driving our sustainable growth.”

Jenness says the financial pressure from the acquisition began to lessen in the 2005 fiscal year. “Since 2001, we have paid down approximately $2 billion of the debt taken on to fund the Keebler acquisition,” the chairman says. “In recent years, we have shifted our focus from debt payment alone to a balance between debt reduction and other uses of cash flow.”

One area that suffered was capital spending. It was $276 million in 2001 but then drifted below that level till 2005, when it jumped by nearly $100 million in a single year. And company officials predict more capital spending this year and next.

The present: Sustaining performance

Chairman Jim Jenness (left) turns over the CEO job this month to David Mackay.

As a result of changes in both the business and the marketplace, the company in 2000 began instituting a two-prong philosophy that remains in place today: Volume to Value and Manage for Cash. “ ‘Volume to Value’ has our entire organization focused on profitable net sales growth, rather than on simply increasing tonnage,” then-Chairman Carlos Gutierrez wrote in the 2003 annual report. “This means adding value to our products through brand-building and innovation instead of relying on price discounts. It also means concentrating our marketing and sales resources on our most profitable brands, as well as launching new products that have more favorable profit margins than our portfolio average.”

Kellogg's sales by year, region and category

In the corollary “Manage for Cash” philosophy, “Cash flow is the ultimate measure of a company’s value,” explains Jenness. “Manage for Cash ensures the organization maximizes cash flow and always makes the best decisions for our stake holders.”

As a result, the company’s approach to capital investment has been conservative. “In 2005, capital spending was 3.7 percent of sales, the lowest in the industry,” acknowledges the chairman. It had been below 3 percent the prior two years. “While we expect this to increase somewhat [it appears headed above 4 percent for 2006, partly due to hearty volume growth] we remain focused on keeping this expenditure to a minimum.”

About the same time Gutierrez was announcing the Volume to Value and Manage for Cash philosophies, the company adopted a simple three-point strategy, which also remains intact today:

• Grow the cereal business
• Expand snacks
• Pursue select growth opportunities