2006 Processor of the Year: Kellogg Co.

Its 2001 acquisition of Keebler not only grew the company and brought it into the world of snacks, it forced a financial and manufacturing discipline that serves Kellogg well today.

By Dave Fusaro, Editor in Chief

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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.

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Kelloggs at a glance

"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.
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."

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

Addressing those points:

  • Despite its migration into other, perhaps similar, categories, Kellogg remains a cereal company first and foremost. It is, in fact, the world's biggest cereal maker, with a 37 percent market share. The company has gained market share in the U.S. RTE cereal business, as already mentioned, and done likewise in other parts of the world.
  • In addition to the Keebler acquisition, snacks have been expanded by two 2005 fruit leather acquisitions. Kellogg bought a Chicago manufacturing plant from Kraft that made fruit-flavored snacks. At the end of that year, Kellogg acquired Stretch Island Fruit Co., an Allyn, Wash., manufacturer of natural and organic fruit snacks. The company continues to operate both of these facilities. The Stretch Island business is managed by the company's Kashi brand.
  • Besides those two fruit snacks acquisitions, which came at a combined cost of less than $50 million, Kellogg has not "pursued select growth opportunities," and company officials are mum are what they may be shopping for.

Kellogg around the world

Kellogg was one of the first American food companies to build plants in other countries. It opened a manufacturing facility in Canada in 1912, and then one in Sydney, Australia, in 1924. Kellogg also was a pioneer in teaching the rest of the world, which was steeped in centuries of either cooked breakfasts or baked goods, the virtues of cold cereal.

Since then, Kellogg has opened many markets and manufacturing plants, with sales in 180 countries and manufacturing plants in 17 of them. In some cases, Kellogg built the business and operations, and in others the company acquired them.

Latin America has been a star. Sales there grew 11 percent in 2005, exceeding even Kellogg managers' expectations (Kellogg would not provide specific sales figures for geographic areas or any other segments). Both cereal and snacks grew by double digits. Kellogg has had a plant in Mexico since 1951. As a result of that long tenure there, Kellogg has 71 percent category share in Mexico.

Europe has been challenging. European sales posted internal growth of 2 percent in 2005, which Kellogg officials termed in line with goals. Even more challenging is Asia-Pacific, including India and Australia. Sales crept up 1 percent in 2005. While corn flakes typically are the tip of the spear, and Special K was just introduced in Japan in 2005, Kellogg has adapted to meet local preferences with products such as Brown Rice Flakes and Black Bean Flakes in Korea, for example.

But the overseas ventures also have been the sources of some of the greatest product innovation and brand development. The Special K Challenge, the highly effective diet promotion currently in the U.S., was first researched in the U.K. before its U.S. launch in 2002. All-Bran was invigorated with line extensions that included yogurt and flakes in the U.K., cereal bars in Mexico and a two-week All-Bran Challenge in Mexico. Now All-Bran is the company's fastest growing global brand, and U.S. brand managers are looking for opportunities to bring the line new success in the U.S.

The future

Don't look for anything too flashy from this conservative company. "Organizational focus is one of Kellogg Co.'s competitive advantages," says Jenness. "We operate in only a few categories, and we know them well."

Financial growth is conservative, as well. "Our long-term internal revenue growth target is for low single-digit growth," the chairman adds. As a result, the company has never disappointed Wall Street.

But there are signs the company is pushing its Special K brand as the next megabrand. Several successful but safe line extensions, all within the cereal, cereal bar and snack categories, have propelled Special K to global sales estimated at $500 million. More of a stretch, a month ago Kellogg unveiled Special K2O protein waters, protein snack bars and protein meal replacement bars. All will be marketed in the diet and nutrition sections of stores. Special K Chocolatey Delight will be launched in January.  The new cereal is designed to allow weight managers to enjoy a decadent-tasting night-time snack while staying on track with their goals. And the brand is appearing in the U.K. on "personal trainer watches," which calculate calories burned.

A significant but not surprising managerial change came last month in the midst of writing these stories. David Mackay, a 21-year veteran of the company (except for six years at Sara Lee) was elevated from chief operating officer to CEO, a title Jenness has held since his election as chairman in 2005.

"David's promotion to our CEO is great - great for our company and great for our shareowners," says Jenness. "This move locks in and further builds visibility for our strong management continuity.  It ensures we stay 100 percent committed to our overarching sustainability performance driver, managing the business with realistic goals and leveraging our focus strategy and operating principles. It also ensures continued appreciation for and belief in the legacy of our founder, Mr. Kellogg. Our Kellogg folks around the world see David's promotion as a positive, natural, well-deserved succession."

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