A report by research firm Bernstein Research indicates that in the first quarter of its fiscal 2017 the company began to “significantly extend payment terms to some of its customers.”
The report said the concern among investors is that this could reflect a lack of leverage on the part of Kellogg with its retail customers.
Bernstein said that the negative view of this practice, or the “bear case,” goes like this: “Kellogg was pressured by its retail customers to agree to a substantial extension in payment terms, which led Kellogg to incur financial costs. This may reflect Kellogg's relatively weak bargaining power in the context of intense competition for retail shelf space.”
Costs are small potatoes—so far
The practice has not yet affected the bottom line, the research firm said, because the company sold a compensating amount of accounts receivable to make the books balance out.
The costs of the practice at the moment are not huge, either, for a company that tops $12 billion in annual revenue. Bernstein said it estimates that Kellogg will spend about $17 million in its full fiscal year to extend the contracts. According to Bernstein, Kellogg has responded to questions about the practice by saying that it received unspecified “commercial advantages” in return for extending the contracts.
Kellogg is far from alone in facing financial headwinds; in recent quarters big CPG firms across the board have seen sales shrink and market shares shrivel, forcing management teams to look to cost-cutting and efficiency efforts as the best near term solution for propping up results and the stock price. Kellogg itself is in the midst of a four-year efficiency program it bills as Project K.
The company expects that by the end of 2019 the program will deliver at least $425 million and $475 million in annual cost savings and perhaps as much as $600 million. By such extreme measures the company was able to slightly improve margins in the quarter, and kept operating profits in line with estimates at about 16%. Kellogg reported $3.25 billion in net sales in the first quarter of 2017, compared to $3.95 billion for the same period a year previously, representing a more than 4% decline.
Diminishing merchandising returns
The biggest CPG brands are also locked in a negative cycle of excessive promotional spending, according to research firm IRI. The firm released a report released late last year covering 62 CPG brands accounting for $20 billion in annual sales and $3 billion in marketing spend that concluded, “Sales lift from merchandising programs has been—and still is—on a steady decline. Excessive (and growing) promotional spending has brands locked in a cycle of commoditization, and margins are being squeezed to near extinction.”
Kellogg is attempting to address this trend by going to a more rational distribution system in which the company will no longer ship directly to customer’s stores but rather to their own warehouses. The savings will free up capital to allow the brand to be more nimble, said Kellogg executive VP Paul T. Norman.
“We need to get more investment behind those brands to go meet the consumer and the shopper how they're shopping. And spend less of that money, if you like, in a distribution system, and move more of that money to pull quite frankly in those brands, when you look at their incrementality, their profitability, there is a lot of growth to be had that we can't get at today, because of the focus of our resource.
"So it is all of the above, including new package formats, more investment in food, more advertising, more shopper marketing,” Norman said in the 2016 year end earnings call with analysts.