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(NATI HARNIK/NATI HARNIK/AP)
(NATI HARNIK/NATI HARNIK/AP)

Market Lab

Soggy sales a wake-up call for breakfast cereal makers Add to ...

Subprime mortgages and exotic collateralized investments weren't the only casualties of the 2008-09 financial crisis. America seems to have lost its taste for breakfast cereal, too.

UBS Securities analyst David Palmer writes in a research report that cereal has been one of the worst performers in the packaged-food segment this year, suffering a 4-per-cent drop in revenues even as the economy returned to expansion. Even price cuts and promotions have done nothing to stem the slide.

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In fact, the declines of 2010 may be part of a longer-term downward trend for the cereal business, which has seen its volumes drop off fairly steadily for much of the past five years. So why have breakfast cereals lost their snap, crackle and pop?

THE SHRINKING BOWL

Up until this year, it would have been easy to simply blame prices. Cereal volume sales had fallen for years in an almost perfect correlation with rising prices, as the run-up in the cost of grain commodities had pushed up costs. But as the accompanying chart shows, that no longer holds true; for much of 2010, volumes have resumed their declines even as prices have fallen. Something else is going on; perhaps the price increases of recent years were masking some other underlying cause.

Mr. Palmer offers several possible explanations. He notes that the cereal industry has been introducing fewer new product innovations in the past few years, and suggests that the lack of inflation in the economy in recent years may have caused consumers to stock up on cereals less than they used to. He even suggests that a recall by Kellogg Co. this summer - due to an "odour problem" with some cereal bags - may have put a dent in sales in recent months.

However, perhaps his most interesting explanations have to do with changes in consumers' whole approach to breakfast. Other options have been taking an ever-bigger bite out of cereal's traditional market, he says.

"Recent trends show that that cereal breakfast occasions have declined in the last year, while breakfast away from home and yogurt consumption [have] increased," he says. "It also appears that children are increasingly replacing cereal with fruits and yogurt."

CRUNCH TIME FOR KELLOGG

Mr. Palmer may be overstating the threat; his own data shows that breakfast cereal is still part of 40 per cent of children's in-home breakfasts, while yogurt is a part of only 3 per cent of kids' morning meals.

Yet he still considers this a trend that poses a threat to Kellogg; he cited it as a key reason why he cut his recommendation on the stock to "neutral" from "buy" last week.

"We are trimming our [earnings]estimate for Kellogg, as we believe that the anticipated turnaround will take longer than we originally expected," the report says. In addition to the drift away from cereals, Kellogg also faces a consumer move away from frozen waffles - another long-time Kellogg offering.

The company is going to have to innovate if it wants to kick-start its stock - and now is as good a time as any to start, Mr. Palmer suggests.

"A potential catalyst remains if Kellogg is able to refocus its innovation efforts and introduce new news for the January shelf sets," he says.

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