Published on July 8th, 2015
Kellogg (K) owns many well-known food brands including Pringles, Eggo waffles, Pop Tarts, Cheez-It, Keebler, and Austin. The company is best known for its iconic cereal brands. Kellogg’s cereal brands include: Special K, Mini Wheats, Rice Krispies, Frosted Flakes, Froot Loops, and Corn Flakes.
Despite the company’s portfolio of well known brands, Kellogg has grown revenue at just 4% a year over the last decade.
The company’s growth has slowed as consumers have begun to switch away from breakfast cereals.
It wasn’t always this way. Kellogg has a long history of success.
The company was founded in Michigan in 1906. Kellogg has paid steady or increasing dividends for 50 consecutive years. It is one of the largest publicly traded packaged good food companies thanks to its market cap of $22 billion. The company’s longevity is a result of it success in a slow changing industry.
Will Kellogg continue its legacy of success, or is the company falling victim to changing consumer tastes?
Recent Results Show Sluggish Growth
Kellogg managed to grow constant-currency earnings-per-share 3% in its most recent quarter. Constant-currency earnings-per-share growth of 3% is well below what investors in Kellogg are looking for.
The company’s tepid growth is a result of its struggles in the United States. North American sales declined 8% versus the same quarter a year ago.
The company is seeing weakness across its North American brand portfolio. Each of the company’s 4 North American segment’s sales declines in its most recent quarter are shown below:
- Morning Foods sales down 2.9%
- Snacks sales down 1.1%
- Specialty Channels sales down 2.5%
- Other sales down 6.1%
The Morning Foods segment is the company’s largest, responsible for 27% of operating profits. Continued sales declines in the segment come from weakness in cereal. It isn’t just Kellogg that is seeing cereal sales decline. Rival General Mills (GIS) is experiencing similar problems as the cereal industry in the United States continues to lose ground.
Kellogg’s ‘Other’ segment is comprised of its Canadian business, frozen foods, and Kashi brand. Other sales declined precipitously. The decline was due in part to a recall last year from certain Morning Star Farms products.
Kellogg is expecting flat or slightly declining constant-currency earnings-per-share for fiscal 2015 as a result of weakness in the company’s United States operations.
Despite all of the declines in North America, Kellogg did post positive constant-currency adjusted earnings-per-share growth in its most recent quarter. The company managed earnings-per-share growth thanks to strength in its international operations.
International Operations Continue to Grow
Kellogg’s international operations saw constant currency growth across the board. Kellogg’s international operations are broken down into 3 segments. Each is shown below along with constant-currency sales growth in the company’s most recent quarter.
- Europe sales up 1.0%
- Latin America sales up 15.7%
- Asia Pacific sales up 4.0%
International growth was led by Latin America. Kellogg has focused on growing Latin American sales in recent years, and the results are impressive.
Kellogg has 55% market share in the Latin American cereal market. The company’s growth in the region is being fueled by strong cereal sales, the reverse of the trend in North America.
Kellogg has significant room for growth in international markets. The company already controls much of the Latin American cereal market. The company is seeing excellent growth in its Pringles brand as well. Pringles sales grew 10% in Europe in the company’s most recent quarter.
Simply put, the international market is much larger than the North American market. Kellogg’s future growth will come disproportionately from international growth.
The company was founded in Michigan, but its future is brightest outside the United States.
The Cereal Growth Plan
Kellogg’s cereal sales have struggled over the last few years. The company has plans to return cereal to growth.
Kellogg fell behind in cereal by not focusing on what consumers are demanding: healthy cereal made with natural ingredients at a reasonable price that tastes good.
Gone are the days that chocolate frosted sugar bombs (not a real brand, but close enough) would fly off the shelves.
Kellogg’s management has changed course. The company is now focusing on the health aspects of its cereals. The company is highlighting when products are ‘gluten free’ and how they provide health benefits. Over time, this new approach to breakfast cereal should return the category to growth. Kellogg’s still owns many of the most well-known cereal brands and has the potential to capitalize on this brand equity.
Kellogg’s Total Return Potential
Kellogg’s management is expecting a long-term earnings-per-share growth rate of 7% to 9% a year. From 2004 through 2010, Kellogg compounded earnings-per-share at 7.3% a year. Keep in mind, much of this growth occurred through the Great Recession of 2007 to 2009.
The company is certainly capable of delivering earnings-per-share growth in line with management’s long-term expectations.
Earnings-per-share have grown at just 4% a year from 2010 through 2014. Earnings-per-share growth has slowed to about 2 percentage points ahead of inflation as Kellogg’s cereal sales have struggled.
The best case scenario for Kellogg is to return to ‘normal’ growth of 6% to 8% a year. If the company continues to struggle in cereal, earnings-per-share will likely grow at around 3% to 5% a year, in line with more recent growth. As a result, the company has a long-term earnings-per-share growth rate of between 3% and 8% a year.
I believe that a return to ‘normal’ growth is significantly more likely than continued slow growth. Kellogg’s brands are too well known, and the company has too much money to put into advertising to not return to its historical growth numbers.
Kellogg currently has a dividend yield of 3.1%. The company’s dividend yield combined with its ‘normal’ growth rate of 6% to 8% a year gives investors total expected returns of 9% to 11% a year.
Valuation & Final Thoughts
Kellogg is currently trading at a price-to-earnings ratio of just 16.6 (using adjusted earnings). The company appears cheap relative to its growth potential and strong brands in slow changing industries.
If Kellogg returns its cereal category to growth, the company will likely trade for a price-to-earnings ratio closer to 20 – a 25% premium over current prices.
Kellogg’s current valuation combined with its high 3%+ dividend yield and potential for solid earnings-per-share growth makes the company a Top 20 stock using The 8 Rules of Dividend Investing. The company is a buy for dividend growth investors willing to look beyond recent weakness in the company’s cereal division.