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Summary

  • By the recent results from Coca-Cola, it looks as if concerns about weak volumes are a thing of the past.
  • With shares trading at $66, Kellogg should command fair value of $70, if management can show improved volumes and strong organic growth.
  • Despite revenue concerns, Kellogg has always remained profitable.

Shares of cereal giant Kellogg (NYSE:K) are up 10% year-to-date, and have seemingly broken out their box. I've complained the past about how Kellogg stock, which was stuck in a trading range between $55 and $60, prompted investors to push away from the table. But investors who have chosen to stick it out have certainly done well. The question, though, is to what extent has management executed to justify the recent hum in share price, or whether Kellogg's prior depressed level was more of an industry-wide issue of weak volumes.

No one is going to argue that Kellogg is still the dominant force in breakfast foods. Although General Mills (NYSE:GIS) and Post (NYSE:POST) have recently narrowed the gap, Kellogg still has the right ingredients, not to mention retail leverage, to distance itself in areas like snack foods. But management has to do a better job of demonstrating organic growth, which has been one area where both Post and General Mills have outperformed. And with volumes showing signs of recovery, Kellogg has to show investors the confidence that they have made the right long-term investment.

Kellogg will report first-quarter earnings results Thursday. Despite the expected 4% year-over-year drop in earnings per share, analysts seem broadly positive. The consensus estimate stands at 98 cents per share, down from earnings of $1.02 per share a year ago. This should be a number Kellogg can easily beat.

Note, the company has posted an average of 44% jump in profits over the past four quarters, including the January quarter, when Kellogg more than doubled its profits from the year-ago quarter. Investors have since responded with the higher stock price. For the full fiscal year, analysts are expecting earnings per share to come in at $3.99, topping last year's mark of $3.86 billion by 6%.

In terms of revenue, the Street will be looking for $3.81 billion, which is expected to be down 1.3% from last year's mark of $3.86 billion. And this is where management has to make its mark. Although revenue has risen by an average of 2% over the past four quarters, Kellogg has been perceived as underperforming both Post and General Mills, particularly Post, which has produced strong double-digit growth. This is because both companies have ramped up ad/marketing spending to attack Kellogg's market share.

On Thursday, Kellogg management has to issue a response, if they want to maintain the stock's recent momentum. To that end, investors have to decide how they will react to an increase in spending. I believe Kellogg has growth opportunities in areas like breakfast shakes and snacks. And in my opinion, the company's recent marketing efforts have not been particularly effective. For the full fiscal year, the Street will be looking for revenue to come in at $15.11 billion, which will be up 2% year-over-year.

That's not a breathtaking number, but to the extent management can offset this with better-than-expected organic growth, the stock should respond favorably. Organic growth measures a company's operational performance using only internal resources and excluding events like acquisitions. Given that Kellogg has not been shy about doing deals, including acquiring strong brands like Keebler and Pringles, organic growth has become a well-followed metric.

Unfortunately, these acquisitions have yet to yield the sort of top line performance the Street once expected, particularly for Pringles, which was considered an expensive deal at $2.7 billion. But as noted, Kellogg has always remained profitable. And with the stock's recent gains, it seems the Street is willing to give management more time to turn things around.

The good news, as evident by the recent results from Coca-Cola (NYSE:KO), is it looks as if concerns about weak volumes are a thing of the past. This means on Thursday, Kellogg has to show a strong revenue number. By "strong," I'm looking for at least a 2% beat to $3.9 billion and upward guidance. With the stock trading at around $66 per share, if management can show better volumes and strong organic growth, I project fair value to reach $70 by the second half of the year.

Source: Why Kellogg Is Heading To $70