From input inflation to domestic uncertainty, investors are understandably reserved about food producers. The Street currently rates Kellogg (K), General Mills (GIS) and Sara Lee (SLE) no better than a weak "buy." Based on my multiples analysis, DCF model and review of the fundamentals, I find that Kellogg and General Mills are fairly valued. But, considering their strong dividend yields and low betas, they provide more of a defensive play than what the Street acknowledges.
From a multiples perspective, the three are appropriately priced. Kellogg is the cheapest at a respective 15.6x and 14.1x past and forward earnings. General Mills trades at a respective 16.9x and 14.1x past and forward earnings while Sara Lee trades even higher at a respective 69.8x and 19.7x past and forward earnings. To put this into perspective, consider that General Mills and Kellogg are trading around their historical five-year average PE multiple.
On the fourth quarter earnings call, Kellogg's management noted a strong finish to a challenging year:
"We delivered continued strong top line growth in the quarter and the full year. In fact, fourth quarter growth was 6% and we ended the year with full year growth of 4.5%, above our long-term targets and in line with guidance. And the growth was broad-based across most geographies and categories. In addition, our categories continue to perform well and we gained share in many of them around the world. However, the results below net sales, while in line with recent guidance, were below our initial expectations and our long-term targets. As you all know, we increased the scope of our existing supply chain investment in the third quarter. This had a significant impact on the fourth quarter and full year results as expected. In addition, increased investment and reinstated incentive compensation costs also had an impact on full year results."
The company has had supply chain difficulties and is in the process of investing in upgrades. While this may be a short-term step backward, it is attractive for long-term value creation. Management is further focusing on launching new products to drive greater top-line momentum. The roll out of Krave, for example, in the U.S. is considered to be a major catalyst. Kellogg recently agreed to acquire Pringles from Procter & Gamble (PG) for $2.7B.
Consensus estimates for Kellogg's EPS forecast are that it will grow by 3% to $3.48 in 2012 and then by 7.5% and 8.8% in the following two years. Modeling a CAGR of 6.4% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $52.20.
Unlike Kellogg, General Mills' recent quarterly performance was weak in the domestic market. EPS of $0.76 was 3.8% below consensus. Pound volumes fell 7% year-over-year in the U.S. markets and the outlook is not particularly strong. The firm suffered from greater advertising spending coupled with the impact from reduced inventories absorbing less fixed costs. Yoplait sales declined 6% in the second quarter, but Yoplait Greek was strong with 50% growth. Management is likely to focus on global penetration to drive value creation, if its $1.4B acquisition of Yoplait international is any indication.
Consensus estimates for General Mills' EPS forecast are that it will grow by 4.8% to $2.60 in 2012 and then by 8.8% and 8.5% in the following two years. Assuming a multiple of 15x and a conservative 2013 EPS of $2.77, the rough intrinsic value of the stock is $41.55. Again, however, with a dividend yield of 3.1% and substantially less volatility than the broader market, the firm provides an attractive income investment.