Kraft Foods Group, Inc. (KRFT -Analyst Report) reported mixed third-quarter 2014 results beating the Zacks Consensus Estimate for earnings but missing the same for revenues as price increases to sustain rising commodity costs hit sales volumes. Shares declined almost 3% in after hours trading.

Third-quarter earnings per share of 78 cents beat the Zacks Consensus Estimate of 75 cents by 4%. Moreover, earnings increased almost 22% year over year gaining largely from lower tax rate. Operating income gains made up for a weaker top line.

Third-quarter adjusted earnings exclude unfavorable impacts from post-employment benefit plans and hedging activities.

Kraft Foods Group, Inc - Earnings Surprise | FindTheBest

Top-Line Weakness Continues

Kraft’s third-quarter net revenue was almost flat year over year at $4.4 billion as pricing gains were offset by lower volume/mix. Organic revenues increased 0.9%.

Revenues missed the Zacks Consensus Estimate of $4.52 billion by 2.6% due to lower volumes.

In the third quarter, volume/mix hurt revenues by 1.2 percentage points (pp), comparing unfavorably with last quarter’s 0.9 pp positive impact due to buying softness as a result of increased pricing in response to rising input costs, especially cheese, meat and roast-and-ground coffee. Weak category growth in meals and desserts also hurt volumes.

Pricing improved 2.1 pp in the quarter, better than 0.6 pp growth in the last quarter, due to commodity driven pricing.

Rising Cheese/Meat Costs Hurt Profit

Rising commodity costs is turning out to be a major margin headwind for the food companies in 2014. The costs of key ingredients like cheese and meat have reached record highs this year compelling Kraft to raise prices of most of its products. The price increases led to market share losses, lower volumes and gross margin weakness.

Adjusted gross profit declined in a mid single-digit range in the quarter as rising input costs and lower volume/mix overcame pricing and productivity gains.

Despite the gross profit weakness, adjusted operating income improved in a mid-single digit rate in the quarter. Lower advertising costs, manufacturing productivity gains and lower overhead costs made up for the weak volumes and increased commodity costs.

Adjusted gross as well as operating income excludes the effects of market-based impacts related to post-employment benefit plans in both years.

Segment Details

Beverage business revenues grew 0.5% (both reported and organic) at $628 million in the quarter as pricing gains partially made up for volume/mix declines. Volume/mix declined 1.1 pp as lower volumes of roast and ground coffee offset gains in Capri Sun ready-to-drink beverages and Kool-Aid powdered beverages. Pricing increased 1.6 pp due to gains in coffee pricing.

Cheese business revenues improved 1.6% (both reported and organic) to $937 million in the quarter due to better pricing which offset lower volume/mix. Pricing improved 4.7 pp in the quarter to cover the rising cost of cheese. Volume/mix declined 3.1 pp propelled by lower demand due to price increases.

Refrigerated Meals business revenues improved 3.4% (both reported and organic) to $908 million driven by pricing gain of 2.9 pp and volume/mix gains of 0.5 pp. New products and continued gains from Lunchables led to the top-line growth.

Meals & Desserts business revenues declined 6.7% (both reported and organic) to $512 million due to weak volume/mix as well as pricing. While volume/mix declined 3.8 pp in the quarter, pricing went down 2.9 pp. Category weakness in both meals and desserts led to the top-line miss.

Enhancers & Snack Nuts business revenues declined 2.5% (down 2.1% organically) to $471 million mainly due to pricing decline of 2.5 pp and lower sales to Mondelez. Volume/mix increased 0.4 pp as continued improvement in Planters snack nuts was offset by declines in salad dressings and peanut butter.

Canada business revenues declined 4.2% to $454 million due to currency headwinds. Organically, revenues grew 0.4% as pricing gains of 4.2 pp made up for volume/mix declines of 3.8 pp. Higher costs of coffee and cheese and the launch of McCafe coffee (partnership with McDonald’s) increased pricing in the quarter.

Other Business revenues increased 5.8% (up 8.2% organically) to $490 million due to pricing gains of 5.0 pp and volume increase of 3.2 pp.

Outlook

In the first nine months of this year, Kraft recorded flat organic revenue growth which lagged broader food and beverage industry growth of 1.7% due to weak volumes.

The Zacks Rank #3 (Hold) company’s top line has been soft ever since the split from Mondelez International Inc. (MDLZ - Analyst Report) in Oct 2012 due to broader macro pressures. Several of its product categories — salad dressings, powdered beverages and ready-to-eat desserts — have been soft for the past few quarters due to consumption weakness and stiff competition. Changes in consumer preferences, shopping behavior and tough consumer spending environment are hurting retail sales. Moreover, ineffective promotional efforts are hurting the company’s sales.

Management expects organic sales growth to continue to lag market rates in 2014. However, in the fourth quarter, management expect to record higher organic growth than the third.

Advertising costs are expected to be lower this year, reflecting efficiency gains. Moreover, due to some execution missteps like recalls and higher-than-anticipated start-up costs, management expects net productivity in the 1.5% to 2% range for the year, falling short of the original target of 2.5%.

Mondelez has also reported disappointing top-line results since the split due to choppiness in the emerging markets and slower global category growth. Other food companies that have been struggling with the top line for the past few quarters are Kellogg Company (K - Analyst Report) and General Mills, Inc. (GIS -Analyst Report). Both these companies’ sales have been hurt by their choppy cereal business.

Get the full Analyst Report on GIS - FREE

Get the full Analyst Report on K - FREE

Get the full Analyst Report on MDLZ - FREE

Get the full Analyst Report on KRFT - FREE