Kellogg (NYSE:K) is on the short list of five or six dozen companies in the world that have outstanding earnings quality - you don't me to tell you that Pop Tarts, Pringles, Keebler Cookies, Frosted Flakes, Fruit Loops, Nutri-Grain bars, and the eponymous Rice Krispy Treats will dwell among us for decades to come. It has compounded at a rate of 11.75% annually over the past three decades, rewarding handsomely those who take seriously the adage "buy and hold."
The problem with buying today at $64.28 per share is this: things are only growing at a single digit-rate in the 4-6% range. Sales have only grown at 5% over the past five years, earnings have only grown at 5%, and the total debt has increased to $7.6 billion. These kinds of figures don't make Kellogg a bad investment, but they do indicate that it's more important to be picky about the valuation from Kellogg than something like a Visa (V), which is growing at north of 15% so that slightly overpaying for that type of growth stock wouldn't prevent you from still reaping great returns.
Kellogg is in this place right now where profits are taking ten or eleven years to double; for instance, over the course of the previous business cycle, Kellogg took until the end of 2010 to post profits of $3.30 that were double the $1.61 profits posted in 2000. The profits increased in every year except one during that time frame, and that is why Kellogg is a nice permanent defensive holding, but since it has a slightly lower earnings per share growth rate than you see from other blue-chip stocks, you should more readily demand a higher discount at the time you make your purchase to offset against the fact that Kellogg doesn't grow as fast as Hershey, Brown-Forman, Colgate-Palmolive, or some of the other typical dividend growth stocks discussed here.
In the past year, Kellogg generated $3.77 per share in profits. At the current price of $64.28, you get an earnings yield of 5.86% or a starting valuation of 17x profits. That's not a bad place to be-if you buy Kellogg today, you will most likely achieve future total returns within hailing distance of what you'd get by purchasing a S&P 500 Index Fund.
But the patient investor can do much better. Kellogg regularly trades at less than 15x profits-you could buy Kellogg at less than 15x profits in 2000, 2002, 2003, 2004, 2005, 2008, 2009, 2010, 2011, and 2012. During the fifteen-year stretch from 2000 through the summer of 2014, you had an opportunity to buy Kellogg at less than 15x earnings during ten of those fifteen years. Waiting for Kellogg to take a haircut of 11% or so from 17x earnings to 15x earnings is not some great hardship; it's an opportunity that presents itself more years than not.
One reason why it would be appropriate to pay a slight premium for Kellogg would be if it seemed likely that Kellogg would have a higher future earnings growth rate per share than we've seen in the past. But there's no indication of this from the company's recent annual reports. In the U.S., sales have gone down 3% and profits have gone down 10%. In the supposedly fast-growing international region, sales declined by almost 10%. None of this will be permanent, and Kellogg will perform better, but the sales information that we have from the company don't seem to indicate that long-term earnings per share growth will be in excess of 6% or so over the coming decade.
If I owned Kellogg, I'd continue to do so, and come up with a good use for the dividend payments while waiting for a price decline at which I could add more. But if you're viewing this investment opportunity with fresh eyes, then it makes sense to wait - an opportunity to buy the company at 15x earnings has always been right around the corner, and waiting for a 10% drop shouldn't be that hard. The only downside is missing out on the dividend payments that occur while your static capital waits for the valuation to come down a bit. That's my opinion, but it's up to you to determine whether that trade-off is worth it to you, and you should draw your own conclusions.
Disclosure: The author is long V. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
