Cereal and snack maker Kellogg Co. said Wednesday its third-quarter net income fell 14 percent, more than expected, as the company invested in its supply chain, adding to pressure from soaring commodity costs.
The world's largest cereal maker also lowered its earnings guidance below expectations. Company shares fell nearly 8 percent in midday trading.
Kellogg, like most food makers, has raised prices to cover rising costs for ingredients and fuel, trying to find the tricky balance between how much prices can increase before consumers forgo loyalty and opt for lower-priced rival brands.
So the supply-chain spending added pressure for the maker of Frosted Flakes, Keebler cookies and Eggo waffles. But Battle Creek, Mich.-based Kellogg said it became apparent the investment was necessary to ensure food safety at its plants, which have faced several health scares over the past few years. Earlier this year, the Food and Drug Administration found traces of listeria bacteria at its bakery in Augusta, Ga., during an inspection. That followed a major cereal recall last year and problems at another plant that led to a shortage of Eggos.
At the Augusta plant, the company reduced production and renovated the plant, and that spurred the wider spending, CEO John Bryant said during a conference call with analysts.
"We sat back and looked at Augusta, got to the root causes within the Augusta facility, and took the lessons learned, fixed Augusta and took it across our broader network," said Bryant.
The company is improving several plants' layouts, adding staff, expanding training and development programs, changing suppliers and increasing independent testing and auditing, Bryant said.
Still, some analysts complained that Kellogg should have discussed the increase in costs earlier.
"These costs should not have been a surprise, in our view, and we wonder how that could have happened," said Citi Investment Research analyst David Driscoll.
Another analyst expressed more distress.
"It seems like the more rocks that are turned over, there's more ugly stuff underneath," Deutsche Bank analyst Erik Katzman said during the call. "And it's amazing that a company like Kellogg with its reputation is actually going through this."
The problems stemmed from cutting its U.S. workforce too much during a cost-cutting program, and overworking its plants and other assets, Bryant said. He said the company is now trying to head off problems, rather than reacting to them as they arise.
Volume fell 1.9 percent during the quarter, but Kellogg said that was expected due to price increases.
Net income fell to $290 million, or 80 cents per share, in the three months ended Oct. 1. That compares with $338 million, or 90 cents per share, last year. Analysts expected 89 cents per share, according to a poll by FactSet.
Revenue rose 5 percent to $3.31 billion, from $3.16 billion last year. Analysts expected $3.41 billion.
In North America revenue rose 4 percent to $2.2 billion. Sales of cereal were flat, which the company blamed on fluctuation in trade inventory. Snack sales rose 3 percent on demand for crackers and cookies. Frozen food sales were also strong.
Internationally, revenue rose 7 percent to $1.1 billion, boosted by the weaker dollar. Results in Latin America were strong and Europe continued to improve.
Kellogg said it continues to expect revenue will grow 4 percent to 5 percent in 2011, but it lowered its net income guidance because of continued investment in its supply chain. It now expects net income of $3.35 to $3.41 per share, from prior guidance of $3.42 and $3.49 per share. Analysts expect $3.48 per share.
In 2012 the company also expects revenue to rise 4 percent to 5 percent with net income, excluding currency fluctuation, up 2 percent to 4 percent.
Shares fell $4.20, or 7.8 percent, to $49.84 during midday trading. The stock had risen 7 percent since January.