Kellogg

Staying on Track for the Back Half of 2006

Kellogg reporting solid results in 1Q2006 and 2Q2006 solidifies continuing growth for 3Q2006 and 4Q2006. We restate an Outperform position rating on Kellogg (K) after this past week's morning's reported earnings. Kellogg reported a $0.67 second quarter and sales were up an remarkable 7.2%. Although gross margin dropped 180 basis points due to higher input costs we believe that this will fade shortly. With a strong half and the year and past earnings we believe that growth in sales and EPS will continue for many quarters in the future.

We believe that Kellogg's fundamentals remain strong and this is seen when looking back to 4Q2005 when Kellogg reported strong earnings ahead of consensus. Cereal sales rose to 8% in the fourth quarter and for the entire year. Although there has been an increase in input inflation, we believe that Kellogg is managing it's way through the current quarter and this will remain consistent for the following year. This has been the second consecutive quarter in which Kellogg has surpassed both the consensus estimate and raised guidance. Kellogg's sales have risen in both volume and price/mix. This is uncommon especially for many other food companies. Kellogg is expanding it's market and at that time we were confident that Kellogg's fundamentals were strong and the firm's EPS would continue to grow.

After several meetings with management and investors, in the beginning of 2006, we believe that Kellogg will sustain earnings growth. There has been several important features that's should be emphasized as it maintains our fervor for this firm. Kellogg has raised pricing on some of its domestic and international retail snack lines. Another factor is the increase of market share in the cereal category. We believe that this increase in market share is due to strong marketing and merchandising. The main focus of Kellogg's marketing is new products. The company's new cereals concentrate on a target market with specific needs. Kashi, ORGANIC, targets the health conscious market. These are drivers of growth in revenues. Although one of Kellogg's biggest competitors, General Mills, continues to show improvements, Kellogg remains successful in capturing market share.

At the conclusion of the CAGNY conference, our opinions of strong performance were reiterated. Two of the biggest features of the conference were advertising and up-front charges. These caught our attention because these two issues are of much concern for investors. Kellogg stated that brand building is much more than advertising and emphasizes that there is great potential for growth. Next, Kellogg discussed three projects that accumulated approximately 20% in returns in the past years. At this time