Packaged Foods Payouts - Whose Dividend Payouts Are Healthier: General Mills Or Kellogg?

 |  Includes: GIS, K
by: David Schauber, Jr.

When determining whether or not to buy an ownership interest in a certain company, there are a number of things that are often considered. Such things include the durability of the company's business model, the company's balance sheet, valuation, and historical earnings growth.

Another important consideration for many investors is the strength and sustainability of the dividend that the company pays out. Dividends are very important, as they accounted for about 42% of the total return of the S&P 500 from 1930 to 2012. The portfolios of many dividend-oriented investors are composed of dozens of dividend-paying stocks from a wide variety of sectors.

In today's article, I will delve into the packaged foods sector with a look at the dividends from two of the biggest companies in that space. They are General Mills (NYSE:GIS) and Kellogg (NYSE:K). I will examine the important aspects of each company's dividend, such as the dividend's history, whether or not the dividend can be covered by the company's earnings, and look for clues as to whether the company can continue paying out and growing their dividends going forward.

Many seasoned investors will look at the two companies mentioned above and say that this article is akin to determining whether Michael Jordan was a great basketball player. There may be some truth to that, but the main idea of this article is to provide a framework by which an investor can determine what company in a given sector has the strongest and most sustainable dividend in the event that the investor can only choose one from the group.

Dividend Yield

Usually, the first and most obvious consideration when analyzing a company's dividend is the dividend yield, which represents the percentage of your original investment that you will get back over the next 12 months, provided that the dividend does not change during that period. Let's compare the dividend yields of the two companies.

General Mills




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Table 1: Dividend Yields Of General Mills and Kellogg

In this case, the dividend yields of both companies are the exact same. So, there's no clear winner in this category.

Dividend Growth

When evaluating the quality of a company's dividend, there is more to it than just the yield. Sometimes, a company's stock may have a high yield due to poor fundamentals that have caused the price of the stock to fall relative to its dividend payout. These poor fundamentals could then lead to dividend cuts, which can then lead to a drop in your net worth.

Dividend growth is another very important factor. For one, dividend growth helps to preserve the purchasing power of your income stream by protecting it against inflation. Secondly, when a company increases its dividend, that is a sign of confidence by management when it comes to the company's fundamentals and future outlook. And third, growing dividends allow investors to share in the benefits of growing earnings. It should also be mentioned that dividend growth can supercharge an investor's yield on cost over the years. For instance, Warren Buffett and Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) received a whopping 40% yield on cost in 2012 on shares of Coca-Cola (NYSE:KO) that were purchased back in 1988. This is due to the dividends that grew almost fourteen-fold since the purchase.

Let's take a look at the dividend growth rates over the last 5 years of our two packaged food stocks. The numbers in the table represent the average dividend growth rate over the last five years.

General Mills




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Table 2: Five-Year Dividend Growth Rates of General Mills and Kellogg

While the dividend growth rates of both of these companies are impressive, easily outpacing inflation, the five-year dividend growth rate of General Mills is nearly double that of Kellogg. General Mills has increased its dividend every year for the last 10 years. Kellogg has increased its dividend every year for the last 9 years.

It's worth noting that the most recent increase from General Mills was by 15%, compared to Kellogg's most recent increase of 4.5%.

Overall, these are good numbers and serve as testaments to the strong business models and long-term earnings growth of these two companies. When looking at dividend growth over the last five years, General Mills is the clear winner here.

Dividend Payout Ratio

In many cases, it's not enough to only look at the dividend yield and the historical dividend growth rates of the stock in question. We need to make sure that the company is making enough money to support these dividend payments. This is where the dividend payout ratio comes into play. It represents the percentage of profits that the company has been allocating toward dividend payments, as opposed to being used for buying back stock or reinvesting into the company's operations. Generally speaking, the lower the payout ratio, the better. This is because lower payout ratios often indicate that there is plenty of room left for dividend increases in the future. Payout ratios that approach or even exceed 100% may indicate dividend freezes or cuts in the future.

Table 3 shows the trailing twelve-month payout ratios, as well as the average payout ratios over the last four years for General Mills and Kellogg. These percentages are based on core earnings (non-GAAP).



4-Year Average

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Table 3: Dividend Payout Ratios of General Mills and Kellogg

From looking at Table 3, neither of the dividend payments of our two companies appear to be in any sort of danger. The payout ratio over the last twelve months for General Mills has expanded some relative to what we have seen over the last several years, due in large part to its big dividend increase last year. The payout ratio of Kellogg over the last twelve months is inline with what we've seen over the last several years. On a 12-month basis, the payout ratio of Kellogg is significantly lower than that of General Mills, implying more room for future dividend increases. However, over the last four years, General Mills has had a slightly lower average payout ratio. The payout ratios of both companies are in really good shape right now, but if you had to choose one or the other here, I would give a slight edge to Kellogg.

But What About Free Cash Flow?

What we just did above was analyze the safety of the dividends relative to the company's earnings. However, earnings don't pay dividends, cash does. And, earnings often include a lot of non-cash items (like depreciation, amortization of patents, asset writedowns, actuarial gains on pension plans, etc.) that can distort one's perception as to the safety of a company's dividend. For this reason, a more accurate measure of determining a company's ability to pay its dividends is the payout ratio based on free cash flow. In other words, what percentage of actual cash that comes in over the course of a 12-month period gets paid out to shareholders?

Table 4 shows the free cash flow payout ratios of our two companies over the last 12 months, as well as the four-year averages. Note that free cash flow is calculated as operating cash flow minus capital expenditures.



4-Year Average

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Table 4: Free Cash Flow Payout Ratios of General Mills and Kellogg

Table 4, like Table 3, shows that the current dividends of each company are well-supported. General Mills has the lower free cash flow payout ratios, both on a trailing 12-month and 4-year average basis.

We should note that the 4-year averages for both companies are skewed a little bit. During fiscal year 2011, General Mills posted a free cash flow payout ratio of 83%. This was due to the company paying $200M in pension contributions and $385M to the IRS in a settlement from a review of corporate income tax adjustments that took place between 2002 and 2008. These items reduced the free cash flow a lot, causing the payout ratio to rise. Then, in 2010, Kellogg had a free cash flow payout ratio of 109% due to paying $467M to its pension plans.

Aside from fiscal 2011, General Mills had a lower free cash flow payout ratio than Kellogg in each of the last five years. So, based on this along with the fact that dividends over the last 12 months accounted for less than half of the company's free cash flow, General Mills looks a little bit better in this area.

Other Tools To Predict Dividend Sustainability Going Forward

Many investors would stop at this point and vote yea or nay as to whether or not the dividends of the company in question are of good enough quality. And that's fair enough. However, what we have done so far is look at past dividend and cash flow data. Aside from what we have done so far, there are some other tools that we can employ in order to evaluate the ability of our four companies to pay out increasing dividends in the future.

Interest Coverage Ratio

The interest coverage ratio is simply the company's earnings before interest and taxes (EBIT) divided by the company's interest payments during the time period in question. This ratio shows whether a company can generate enough money to cover its interest payments, which must be made before any dividends can be paid out. The higher this ratio, the better. If the company is paying an exorbitant amount of interest relative to its pre-tax profits (a low interest coverage ratio), then that doesn't leave much room for dividends, which may be indicative of dividend cuts in the future. For this reason, dividend investors like to see high interest coverage ratios.

Table 5 shows the interest coverage ratios of General Mills and Kellogg over the last 12 months.

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Table 5: Interest Coverage Ratios of General Mills and Kellogg

From Table 5, we see that the interest coverage ratios of both companies are in pretty good shape. However, Kellogg gets the edge here, as it has covered its interest obligations 12 times with pre-tax earnings over the last 12 months.

Net Debt To Equity Ratio

The net debt to equity ratio is also very important. The amount of debt not only influences the amount of interest that must be paid, but also, the amount of debt that at some point will need to be repaid. Right now, a lot of companies are choosing to refinance their debt due to the presence of very low interest rates, as opposed to paying it off. However, if and when interest rates go higher, refinancing may be a less attractive option. As a result, extinguishing debt may have an effect on future dividend payments.

The net debt to equity ratio is calculated by dividing the net debt by the company's equity position. Net debt is simply the combination of short and long-term debt minus the company's cash position. The lower this ratio, the better. Ratios typically below one are considered to be good. Table 6 shows the values of these ratios for our two companies.

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Table 6: Net Debt To Equity Ratios of General Mills and Kellogg

From Table 6, we see that while neither company looks great in this area, General Mills looks better than Kellogg. However, both companies have a significant amount of treasury stock on their balance sheets. This treasury stock represents a reduction in the company's equity, inflating the net debt to equity ratio.

A lot of companies don't need a lot of equity in order to run their businesses, so they use a lot of their equity to buy back stock. This can artificially raise the net debt to equity ratio, making a company appear to be more financially-distressed than it really is. This is the case for both General Mills and Kellogg. For this reason, I like to calculate what I call the adjusted net debt to equity ratio. It is calculated the same way as the net debt to equity ratio, except that the negative impact from the treasury stock is stripped out from the calculation.

When we do this, General Mills has an adjusted net debt to equity ratio of 0.71, while Kellogg has a ratio of 1.08. Here, we see that the treasury stock made a big difference, and neither company is suffering from any major financial distress.

When it comes to who is better, I give the nod to General Mills.

Earnings Per Share Growth Forecasts

While dividend growth can be achieved to some extent through the expansion of the payout ratio, ultimately there must be free cash flow growth in order for there to be long-term dividend growth. And, free cash flow growth stems largely from earnings growth. In order to get a better idea as to whether the company can sustain growing dividends going forward, you may want to consider analyst projections for earnings growth over the next couple of years. Table 7 shows earnings per share growth estimates for both companies from the analysts at S&P Capital IQ. The estimates are for fiscal 2014 and 2015.




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Table 7: Earnings Per Share Growth Forecasts for General Mills and Kellogg

Here, we see that both companies are expected to grow earnings per share by an average of about 7% over the next couple of years. This is decent growth that should allow for dividend increases in the future. Keep in mind that earnings per share growth can be fueled by stock buybacks as well as by cost cuts and revenue increases. When shares are repurchased, the same amount of money that's allocated for dividends will be divided among fewer shares, resulting in per-share dividend increases, without actually having spent more money on dividends.


In this article, we have analyzed the dividend strength of General Mills and Kellogg by looking at a number of factors, including the dividend yield, dividend growth rates, payout ratios, interest coverage ratios, net debt to equity ratios, and analyst estimates for earnings per share growth. From looking at all of these items, it can be said that none of the dividends from these two companies appear to be in any kind of danger at this point in time.

Kellogg has a free cash flow payout ratio of just 56%, leaving room available for future dividend increases. With an average dividend growth rate of around 6% over the last five years, and expected earnings per share growth of 5%-9% over the next couple of years, it's reasonable to expect continued dividend growth in the mid single-digit range. There is the possibility of higher dividend growth due to future expansion of the free cash flow payout ratio, but given Kellogg's recent dividend growth history, I'm expecting more of the same.

General Mills has a free cash flow payout ratio of 48%. With dividend growth averaging 12% over the last five years, we may see similar double-digit dividend increases in the future, not only from earnings per share growth, but also from expansion in the free cash flow payout ratio.

Due to higher dividend growth rates, a lower free cash flow payout ratio, and a balance sheet with less leverage, I prefer General Mills over Kellogg.

And, of course, before making a final investment decision, you need to consider other things such as valuation, business models, and geographic footprint to name a few.

For more information on how I analyze financial statements and dividend strength, please check out my website at this link. It's a website I created just for fun, as well as to help fellow investors make intelligent financial decisions. Thanks for reading and I look forward to your comments.

Disclosure: I am long GIS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.