These companies have been around longer than I have. They have grown more than I have. The two love vitamins and the food pyramid. The brands make chocolate look healthy. Nutritional components in their products contain just the right amount of vitamin D and C to help absorb your calcium and iron. Who am I talking about? They are your morning informal Spanish nouns referring to a friend (compadres); General Mills, Inc. (NYSE:GIS) and Kellogg Company (NYSE:K).
How are the Financials and Valuations?
Before I invest in any company, I must make sure their income statement, balance sheet, important ratios, and cash flows are doing better than most of its peers. When I am in the cereal line, I always have a tough time deciding between Frosted Flakes and Frosted Cheerios. Let's take a look at one of GIS's equivalent peer in the packaged food industry and see how their progress compares to each other and the industry.
K vs. GIS
Symbols: Increase (+)/ Decrease (-)
Changes Between 2011-2013
Free Cash Flow
Comparison with Industry Averages
Operating Margin % TTM
Net Margin % TTM
Logic and Analysis
The reason I am comparing these two companies is because they have around the same market capital and cater to relatively the same consumer base. Based on the above data, we can clearly see GIS is in a better financial situation than K and the industry. With a huge amount of free cash flow, GIS is equipped to handle the upcoming competition while keeping their investors happy. Return on Equity (ROE) demonstrates a company's profitability, asset management, and financial leverage. Both GIS and K are doing better than the industry, however GIS is doing significantly better on their returns than K. Breaking the total debt/ total capital ratio into a percentage, GIS is sitting slightly above the industries average at 55%. GIS's operating profits are 12 times greater than interest payments. GIS will have no problem paying its debt. Unfortunately K is in a tougher situation with a total debt/ total capital ratio of 72%. The companies operating profits are only 9 times greater than its interest payments. This does mean it can easily pay off its debts; however, it will have less free cash to allocate elsewhere.
GIS vs. K
GIS has a huge relationship with Nestle (NRGY), a company with a market capital of $236 billion. GIS and NRGY have a 50/50 partnership in an organization known as Cereal Partners Worldwide (CPW). This partnership brings in 84% of its $1.3 billion in international sales; the rest coming from Haggen-Dazs Japan (HDJ).
GIS has expanded its operations to over 120 countries. This international expansion accounts for roughly 40% of its sales. Growing markets in China, Latin America, and Eastern Europe are where most of their global goods are sold. GIS involving themselves in these international joint ventures allows them to take advantage of revenues and profits through international firms which understand their domestic market. If GIS were to start from scratch overseas, they would have fierce competition and lack experience in the international business arena relative to its domestic peers.
K is also invested in international markets using the same logic as GIS. Although K is number 1 in the ready-to-eat cereal market here in the US; overseas, they lack the business strategies and resources to be as competitive. In order to be a threat to GIS and other industry peers, K is planning on laying off 7% of their workforce by the end of 2017. This could help save the company around $427 million which can be used in R&D and marketing; if not eaten up by their debt.
Recently K has made a few smart moves which will allow them to expand their international market. They recently partnered with Willmar International, a Singapore agriculture business with more than $40 billion in sales. Using GIS's strategy, Willmar will have a superior understanding of their domestic market allowing for greater marketability and revenue for both companies.
Another international player for K will be Pringles. They recently purchased the product from Procter & Gamble (NYSE:PG), an equity traded in four countries. PG focuses more on their household and personal care items. The previously poor and neglected Pringles will generate 1/10th of K's international sales; second behind its cereals. Although these are a few great moves for K in the years to come, it's nothing compared to the expected revenues GIS's international ventures will generate. The amount of free cash flow, less debt, and greater operating margin will allow GIS to expand quicker overseas and domestically; especially due to a number of new acquisitions and alterations in their product line expanding their consumer population.
GIS recently conquered the yogurt industry with Yoplait. It didn't stop their however, they also bought a stake in Yoki, a Brazilian firm which has the number 1 position in the dry meals category. According to GIS, 85% of Brazilians have consumed a Yoki product within the past 6 months.
Free cash flow won't only be used on these partnerships, GIS is also committed to catering to their numerous health conscience consumers. By 2020, GIS is committed to find a sustainable and eco-friendly source for its top 10 ingredients. The chart below, taken from GIS's site, goes more in detail in regards to the exact ingredients and GIS's plan for each one.
100 percent of the company's oats will be sourced from growing regions that demonstrate continuous improvement against industry-based environmental metrics.
100 percent of General Mills' U.S. wheat will be sourced from growing regions that demonstrate continuous improvement against the Field-to-Market framework or comparable environmental metrics.
100 percent of the company's dry milled corn will be sourced from growing regions that demonstrate continuous improvement against the Field-to-Market framework or comparable environmental metrics.
100 percent of General Mills' directly sourced fluid milk will originate from producing regions that demonstrate continuous improvement as measured by the Dairy Sustainability Framework (U.S.) or other comparable environmental metrics (globally).
100 percent of the company's fiber packaging will be from recycled material or from virgin wood fiber regions that are known TO NOT BE contributing to deforestation. Any high-risk regions will be independently verified.
100 percent of General Mills' cocoa will be sourced through origin-direct investment, which will improve the incomes of smallholder farmers and the quality of ingredients
100 percent of the company's vanilla will be sourced through origin direct investment, which will improve the incomes of smallholder farmers and the quality of ingredients.
100 percent of the company's palm oil will be sourced from responsible and sustainable sources in 2015.
100 percent of General Mills' sugar cane will be sourced from responsible and sustainable sources.
100 percent of the company's U.S. beet sugar will be sourced from growing regions that demonstrate continuous improvement against the Field-To-Market framework or comparable environmental metrics.
GIS is also removing GMOs from their number one brand, Cheerios. The oats are already free of genetically modified ingredients. Corn Starch and Sugar Cane will now also be GMO free. This change only pertains to the plain flavored cheerios. Organizations such as UN World Health Organization (WHO), UN Food and Agriculture Organization (FAO), and U.S. Food and Drug Administration (FDA), all agree that there is no harm in GMOs. However, many health nuts, which are attracted to plain cheerios, disagree without proper scientific evidence. GIS's main intention for this alteration is to expand consumer base. A good analogy to this venture can be seen in the vitamin industry. Unless one has very poor nutrition, there are less than a handful of supplements beneficial to the human body on a daily basis. With that being said, companies like GNC make a killing over the sales of unnecessary products which have no health benefits whatsoever. The term 'Genetically Modified' scares consumers; especially those who only eat organic. GIS's and other companies main reason to use this technology is to grow food at a more efficient rate, both cost and time, in order to better accommodate for consumer needs. Due to this technology, many charitable hunger crises have been addressed. Although unnecessary, GIS's profits will increase by making this change. Cheerios is their number one ready-to-eat cereal franchise accounting for a 13% share in the market.
Even with their recent acquisitions of Yoplait and Yoki, GIS did not suffer a loss in profits. GIS has been using 1.2% of their sales for R&D expenditure and 5% for marketing. K has Pringles and Willmar International in their pipeline. GIS has a better financial valuation, tremendous amount of free cash flow, Yoplait, Yoki, GMO free products, and much more in their upcoming future.
Unfortunately, since both companies have a similar strategy to expand their business, they face many of the same hurdles. Expanding in an international market makes the companies susceptible to losses due to currency fluctuations and political unrest. Private sectors making many of the same products for a less expensive price will also affect sales for both companies.
The upside is that the executives of both firms have a huge incentive to make sure both investors and the company as a whole succeeds. Greater than 75% of the executive payroll for both K and GIS is tied to performance. With stock ownership requirements in place for CEOs and senior executives, shareholders will not be overlooked.
Given K's fierce competition, especially with GIS's bullish pipeline and relatively narrow economic moat, K definitely needs to step up its game.