Despite coming under pressure from rising raw materials costs, food giant Kellogg Co. (NYSE:K) reiterated its earnings guidance for the year. Its shares have had a nice rally, climbing about 13 percent over the last six months, against an industry average of roughly 11 percent and a relatively flat performance in the S&P 500 index. But its valuation appears to be a mixed bag, varying with different metrics. Our analysis suggests that there might be some more room left to grow.
At first glance, it seems difficult to get a handle on Kellogg's price tag. Its price to earnings (P/E) ratio - arguably, the most commonly used valuation metric - depicts the cereal maker's shares as trading at a discount to the industry average. But its P/Sales ratio puts it at a premium. As indicated below, different metrics paint different pictures of Kellogg's price tag relative to the average of its peers in the food processing industry.
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The key issue with these metrics is that they are based on the company's past performance. While they are useful for providing a quick comparison, stocks are at least theoretically valued on expectations of future performance. For this reason, it is important to look at Kellogg's shares while taking into consideration estimates for earnings per share.
At present, the company expects to post EPS between $2.45 and $2.49 this year. Analysts seem to be a bit more bullish. In a Reuters poll, analysts on average currently look for the company to earn $2.51 - unchanged from two months ago. A touch of optimism among the analysts is not entirely unexpected given that Kellogg beat the consensus estimate in each of the last four quarters by varying degrees, ranging from 2.7 percent to 7.3 percent.
Of course, there is nothing to guarantee that Kellogg will continue to beat estimates. With that in mind, let's use the company's own estimates to give us some idea of what to expect down the road. Using the mean of the endpoints of the range, $2.47, and its current stock price of about $50, Kellogg is priced at a forward P/E ratio of about 20.2. By itself, this number does not provide much insight. But, when we compare it to the consensus estimate for a long-term EPS growth rate - 9.18 percent - we get the PEG ratio. Although the die-hard value hunters typically only focus on companies with PEG ratios south of 1.00, numbers a bit north of this threshold are still in value territory. Kellogg's reading of 2.2 is a lofty PEG ratio.
Our back-of-the-envelope analysis, though, paints a slightly different picture. We take into consideration such factors as the company's EPS growth rate over the last five years, as well as its performance over the trailing 12-month [TTM] period and in the most recent quarter [MRQ].
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Weighing these factors, along with the company's EPS estimate, we find that Kellogg can grow its earnings at an average annual pace of about 10 percent - a bit faster than the pace expected by analysts and less than the 5 percent needed to justify the stock's current price.
Given that Kellogg also doles out nearly 45 percent of its earnings to shareholders, we also take into consideration its dividends.
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Companies' payout ratios are not static over time. So, we weight Kellogg's more recent payout ratios more heavily than the payout ratios farther back in time. Our analysis suggests that Kellogg can grow its dividends at a clip of about 4.9 percent. This also compares favorably with the 2.9 percent growth that seems to be required to justify the current stock price.
At the time of publication, Erik Dellith did not directly own puts or calls or shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.
Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.