A Cereal Killer?
Snap, crackle--kaboom?
Giant cereal maker General Mills Inc. (ticker symbol: GIS) last week tried to buck the industry’s long spell of price-cutting by raising prices--a risky move that left Wall Street sharply divided about the outlook for cereal companies’ stocks.
Some observers cheered the 2.6% average price markup, figuring most of the companies would follow General Mills and also lift retail prices. That could pad their profit margins in this otherwise slow-growth, $8-billion domestic market, and give their stocks a boost. A few analysts immediately raised their ratings on the stocks as well.
Others, though, fret that if General Mills and the others raise prices, rebellious consumers will shift more toward generics and other lower-cost cereals (as they have before), and the stocks will suffer.
There’s also speculation that General Mills’ rivals won’t raise prices, so as to protect their market shares.
That’s just what happened two years ago, when General Mills--maker of Cheerios, Wheaties and other popular brands--raised prices 3%. Industry leader Kellogg Co. (K), which has about a third of the U.S. cereal market, decided to hold prices steady, and prospects for higher prices industrywide quickly vanished.
Kellogg, in fact, hasn’t lifted prices across the board since early 1994. And General Mills said that from 1993 to ‘96, it slashed prices between 10% and 20%.
“Naturally, the Street is extremely skeptical” that price hikes can stick this time around, Lehman Bros. analyst Michael Branca said even as he raised his rating on General Mills to “buy” from “neutral.”
Wall Street has reason to be dubious. Although the price-cutting has been a boon for cereal fans--the typical box of cereal now retails for less than $3, about where it was five years ago--it’s been bad news for investors.
As the accompanying chart shows, the stocks of General Mills, Kellogg and Quaker Oats Co. (OAT) have badly lagged the broader market’s gains for the last 3 1/2 years.
To be sure, investors must realize that two of the big players--Quaker Oats and Philip Morris Cos. (MO), whose Kraft Foods unit makes the Post brand of cereals--have had plenty of other problems to deal with besides ready-to-eat cereal, problems that have also had an impact on their stock prices.
Quaker Oats wrestled with the fiasco of buying beverage maker Snapple for $1.7 billion, only to let the brand wither before selling it for a meager $300 million in the spring. The $1.4-billion difference was charged against Quaker’s first-quarter results this year, leaving it with a $1.1-billion net loss.
Meanwhile, Philip Morris has been buffeted by the litigation involving its enormous cigarette business, which culminated recently with the tobacco industry agreeing to a historic $368-billion settlement. Indeed, Kraft overall accounts for only 29% of Philip Morris’ sales, and cereal even less.
Nonetheless, it was Philip Morris’ Post division that triggered a dramatic round of price cuts in April 1996, a move that stepped up all of the cereal makers’ need to cut their operating costs further or risk seeing their profit margins get even thinner.
No company felt the pressure to lower expenses more than Kellogg--producer of Frosted Flakes, Corn Flakes and Raisin Bran, among many others. Kellogg not only was losing market share to generic and other lower-cost cereals, its earnings were also under attack.
In 1996, Kellogg’s net income (excluding one-time charges) tumbled 15% from a year earlier, to $651 million on sales of $6.7 billion. Earnings dropped an additional 22% in this year’s first quarter.
Now Kellogg says its cost-cutting and streamlining efforts will start paying off with improved results. And General Mills’ action last week sent Kellogg’s stock sharply higher; at one point it set a 52-week high of nearly $93 a share.
Yet the Street is still divided over Kellogg. Although food analyst Nomi Ghez of Goldman, Sachs & Co. added Kellogg to the firm’s “recommended” list of stocks, Timothy Ramey of Deutsche Morgan Grenfell put out a rare “sell” on the stock.
Ramey couldn’t be immediately reached Monday to explain his action.
Ghez said that “all eyes on are Kellogg” to see if it matches General Mills. “If Kellogg doesn’t do anything, no one else will dare,” she said.
Merrill Lynch & Co. analyst Eric Katzman said he’s recommending Kellogg as a “long-term buy,” even though he does not expect it to raise prices. The company’s cost-cutting efforts preclude taking that action, he said.
“Kellogg has stressed they want to gain market share, and raising prices doesn’t mesh with that objective,” Katzman said.
He doesn’t expect Quaker Oats or the others to raise prices, either, because “they have the cost savings in place to deliver the earnings” they have forecast for investors.
Otherwise, analysts are generally cautious toward Quaker Oats as they wait to see how the company restructures itself in the wake of the Snapple mess.
Additionally, smaller asset sales are likely by the company, but in the meantime Quaker’s cereal sales are expected to keep growing, analysts said.
Ghez is among Quaker Oats’ fans. She rates the stock to outperform the general market and said “the company will do better than analysts generally expect.”
As for General Mills, Lehman’s Branca likes the stock partly because he considers it cheap--trading at barely 19 times the per-share earnings he expects the company to record in 1998, or about 10% less than the price-to-earnings ratio for the food group overall--and because he believes Wall Street’s skepticism about General Mills’ price hike will actually benefit the company.
How? With Wall Street’s expectations so low, “any positive impact on the earnings line as a result of this price increase” will send the stock higher, he predicted.
Although Wall Street is uncertain whether everyone will raise prices, some analysts said they have detected a desire among the cereal makers to end the repeated price cuts.
Shortly before General Mills’ price hike, analyst John Bierbusse of A.G. Edwards & Sons Inc. in St. Louis said that “the tone of the cereal industry is slowly shifting back to one of profitability rather than market share and volume gains” arising from recurrent reductions in retail prices.
That shift would pinch consumers, but it could be bullish for the other major cereal maker--Ralcorp Holdings Inc. (RAH), which is the leading producer of generic cereals that supermarkets and others sell under their own brand names.
Ralcorp has been pinched by the big players’ price-cutting, because the lower prices narrowed the advantage Ralcorp enjoyed as the purveyor of less-expensive generics.
If General Mills and others can keep their prices rising, “this trend should speed earnings recovery at Ralcorp as the pricing gap between branded and private-label widens,” Bierbusse wrote in a report in which he placed a “buy” rating on Ralcorp.
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Times staff writer James F. Peltz can be reached at james.peltz@latimes.com
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Crunch Time
General Mills is taking the risky step of raising cereal prices, leaving Wall Street divided about prospects for stocks of the major producers of breakfast cereals. Here are the players:
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Ticker Recent 12-month % Change from Stock symbol price % change Dec. 31, 1993 General Mills GIS $67.50 +27% +36% Kellogg K 89.25 +23 +60 Philip Morris MO 44.50 +31 +145 Quaker Oats OAT 45.25 +40 +29 Ralcorp* RAH 17.25 +39 * S&P; 500 +40 +97
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* Feb. 3, when Ralcorp split in two by selling its branded cereals to General Mills but kept its private-label cereal business.
Source: Bloomberg News
