Just as Kellogg (K) investors were getting used to the idea that 2012 was going to be a year of somewhat depressed results and necessary reinvestment, Kellogg posted a rather curious quarter. Though this company is still one of the best names in food to own for the long haul, investors with more short-term concerns had best be ready for some potentially choppy results this year.
Surprising Strength To Start The Fiscal Year
Revenue at Kellogg was a little stronger than expected, growing about 6% on an internal basis. Arguably the biggest surprise is that the company was able to balance a better than 6% boost in prices with less than 1% volume erosion. Growth was strong in both North America (up nearly 7%) and Latin America (up more than 10% in constant currency), while Europe was down about 1%. Internal growth of more than 8% in Asia was likewise a solid result.
Going into the profits is where I get confused. Gross margin was down about 70 basis points, and that's not all that confusing - higher grain prices, higher energy prices, higher freight prices, etc. But Kellogg also reported that SG&A spending fell 3% from last year and more than 5% sequentially, fueling a 21% year-on-year improvement in operating income (with solid double-digit growth in North America).
Perhaps I misunderstood the company's management during the last earnings call, but I thought 2012 was going to be a year with almost $100 million in incremental spending on things like supply chain improvement and brand-building (i.e. advertising). Unless Kellogg is simultaneously making some major offsetting cuts, it looks like there's still more to come on the SG&A line as the year develops.
Better Foreign Performance Is A Long-Term Project
I want to take Kellogg to task for having relatively low foreign sales, especially when compared to the likes of Colgate-Palmolive (CL), Procter & Gamble (PG), and Unilever (UL). I fully recognize, though, that comparing food to personal care (or an admixture of the two) is not fair. What's more, though Kellogg may lag pre-split Kraft (KFT), Nestle (OTCPK:NSRGY), PepsiCo (PEP) and perhaps Campbell (CPB), Kellogg actually is pretty globally diversified by the standards of the industry.
Still, there is more that the company can do here. For too long Kellogg has, in my opinion, tried to force non-North American customers to adapt to American tastes and consume Kellogg products the way Kellogg wants them to, instead of adapting their brands to regional tastes. Who cares if Pop-Tarts and cereal are snack items or dinner alternatives, so long as people eat them?
That said, there's more blocking and tackling work for Kellogg in markets like the UK - Kellogg's largest foreign market and one in which Kraft and Nestle have been taking advantage of Kellogg missteps.
Time To Deal?
It's also worth noting that outside of the Bear Naked acquisition in 2007, Kellogg hasn't done much in the way of M&A since the 2001 acquisition of Keebler. Not surprisingly, I would be in favor of deals with either good OUS exposure or easily nexploited synergies. That said, Kellogg's balance sheet probably precludes much in the way of deal-making.
The Bottom Line
Kellogg has a great franchise - largely splitting the lucrative cereal market with General Mills (GIS) and Post once Ralcorp (RAH) finishes the spin-off. Other businesses like cookies, crackers, and vegetarian meals hold solid share in their markets. Look further at metrics like return on capital and free cash flow conversion and I have no quarrel with Kellogg's place on many top-stock lists.
The issue, though, is whether Kellogg is cheap enough to buy today. To me, the answer is "not really," or at the very least, "not yet." I'm still uncertain about the company's reinvestment spending intentions for 2012 and a little concerned about how investors may digest that process. Moreover, even granting the assumption of mid-single-digit compound cash flow growth doesn't leave these shares looking dramatically cheap when the debt load is factored in.
I'd be relatively content holding these shares if I already owned them, but I would need to see a bigger discount to fair value before I would put new money to work in Kellogg stock.