Kellogg shares climbed 2% on Tuesday, following the news that the food maker would split into three companies—its cereal business, global snacking brands, and plant-based protein products. Today the shares are 1% lower. Should investors be buying the stock? It depends on what they’re craving.
Kellogg (ticker: K) has climbed over 5% year to date, a period that’s seen the S&P 500 tumble 21%. That’s largely due to the fact that the market is favoring defensive names like consumer staples, which typically enjoy more stable earnings flows. After all, no matter how bad the economy gets, you still need to eat breakfast.
On the flip side, that breakfast doesn’t have to be brand name cereal—and skeptics argue that after pandemic-fueled growth, consumers will choose to make just that tradeoff as inflation squeezes budgets.
Looking purely at price and payout, for bargain hunters, the shares present a fairly attractive proposition in the packaged food industry, which has held up relatively well compared with the broader market in 2022.
Kellogg trades at 16.4 times forward earnings, not far above its 15.5 average for the past five years. That may not look particularly cheap at first blush, but peers like Coca-Cola (KO), PepsiCo (PEP), Mondelez International (MDLZ) and Colgate-Palmolive (CL) all trade at 20 or more times. Fellow cereal maker General Mills (GIS) changes hands for more than 17 times, and Post Holdings (POST), which also sells private label offerings that often increase in popularity during economic downturns, has been bid up to more than 28 times.
It’s worth noting that Kellogg’s generous 3.4% dividend is comfortably higher than all those stocks’ yields as well.
Investors wouldn’t necessarily compromise on growth much either. While consensus estimates may move around to factor in the spinoffs, at present analysts expect Kellogg earnings to climb by nearly a third this year, and more than 50% in 2023. The company’s most recent earnings, reported in May, were ahead of expectations.
That quarter may have been a bit of an outlier though, given that Kellogg hasn’t been terribly consistent in beating consensus earnings expectations in recent years.
Nonetheless, it did provide steady earnings per share growth during the 2007-09 recession: Kellogg grew earnings to $2.76 a share in 2007, up from $2.51 in 2006, and in 2008—one of the most painful years for the U.S. economy in recent decades—EPS climbed again to $2.99. That figured reached $3.16 in 2009.
Of course Kellogg’s portfolio has changed in the intervening years and once the company splits, 2008 will offer even less of an apples-to-apples comparison. Still, the spinoffs won’t be complete until the end of 2023, so given that bears fear the economy may tip into a recession near term (or has already done so), past performance does provide some comfort.
In fact, Barron’s has argued that brand name foods are better positioned postpandemic than they have been in some time.
Yet what of the spinoffs themselves? That presents more of a mixed bag for investors.
Indeed those focused on stability may want to steer clear. The spinoff creates execution risk at a time when brand name consumer companies are already facing increasing risks.
The pandemic provided tailwinds in that more people were eating at home, had stimulus funds to spend at the grocery store, and tight supplies meant that sales were few and far between.
Now people are venturing out again—restaurant spending has been up double digits year over year in recent months. Inflation has crimped grocery budgets, and while companies may want to raise prices to cover the increased cost of raw materials, retailers may pressure them to do just the opposite to retain customers. Management needs to stay laser focused to remain on top of this fast moving environment.
Then there’s the fact that the attempt to unlock higher multiples for Kellogg’s faster growing businesses could backfire—a concern even among bulls. Morningstar analyst Erin Lash still thinks the shares are attractive, but factors from reduced scale to dis-synergies would lower her fair value estimate for the company to $83 from $88, as she doesn’t think the move will “enhance Kellogg’s competitive position or financial prospects.”
Likewise, other analysts question that a sum-of-the-parts analysis yields much in the way of enhanced value. Credit Suisse analyst Robert Moskow writes that “if Global Snack Co. were to fetch a higher valuation multiple akin to global snack leader Mondelez (16 times earnings before interest, taxes, depreciation and amortization), the valuation would increase to $80 a share. But with only 60% of Global Snack Co.’s sales actually coming from snacks and 40% coming from slower-growth breakfast cereal, noodles, etc., we think a 14 times EBITDA multiple is more appropriate.”
That said, those with a longer-term view may find more reasons to bet on increased value than not.
UBS analyst Cody Ross writes that the move is likely a welcome one for shareholders, as he believes it should “enable Kellogg to earn a higher multiple for its faster growth snacking business and plant-based businesses, while allowing more strategic investments in them over the long-term.”
Likewise, if the company can prove that its growth wasn’t just pandemic-dependent over the next year or so, that would add more fuel to the argument that its fastest-growing components are worth more.
Evercore ISI analyst David Palmer argues that Kellogg is “worth more apart.” While he thinks the future Global Snack Co. deserves to trade at a slight discount to Mondelez for various reasons, he thinks it will ultimately likewise notch a mid-single digits organic growth rate. In addition, Kellogg’s “power snacking brands of Pringles and Cheez-It represent about a third of sales having grown 13% and 10%, respectively, and remain key growth drivers going forward.”
All that is a lot of food for thought for investors—they’ll have to determine how much spicy risk suits their palate.
Write to Teresa Rivas at firstname.lastname@example.org