Kellogg Company (K) reported strong third quarter results. Better results for the company were mainly driven by the recent acquisition of Pringles. The results were partially offset by higher commodity costs and manufacturing issues, which forced the company to recall some cereal packages. The company is expected to grow at a rate of 5% per annum for the next five years. Kellogg's valuations are almost in line with General Mills (GIS) but cheaper than those of PepsiCo (PEP). We recommend that dividend investors buy the stock. However, we are not looking for any capital appreciation.
Kellogg Company is the leading cereal and frozen foods producer in the world. It has production operations in more than 18 countries and its products are marketed in more than 180 countries. Brands offered by the company include Coco Pops, Corn Flakes, Eggo and many more. The company has annual sales of almost $13 billion. Kellogg is also the second largest crackers and cookies producer.
Kellogg announced its third quarter financial performance last week, which was better than what the market and analysts were expecting. It reported net sales of $3.72 billion, representing an increase of 12.3% YOY. Analysts were expecting net sales of $3.69 billion for the recent third quarter. Top line growth of more than 12% for the quarter was mainly driven by the recent acquisition of Pringles. This acquisition has made the company the second largest salty snack maker in the world, after PepsiCo Inc - Frito Lay. Excluding the impact of the Pringles acquisition, net sales for the company grew by 2.8%.
The company has a geographically diverse revenue base, with almost 65% of total revenue coming from North America, while the remaining 35% earned from international markets. For the recent third quarter, net sales for North America grew by 11%. Internal sales, excluding the impact of the acquisition, were up by 3.7%. On the other hand, Kellogg's international net sales were up by 14.8%, while internal net sales grew by 3.6% for the segment.
Kellogg reported net earnings of $0.82 per share, or $296 million, in 3Q 2012, up 2.5% from $0.80 per share in 3Q 2011, beating the analyst earnings estimates by 1.5%. Acquisition related costs cut down $0.04 per share in 3Q 2012.
The company had to face problems related to possible fragments due to which it had to recall some packages of Mini- Wheat's. Kellogg also faced a similar problem in 2010, when it had to recall millions of cereal boxes because of an unusual smell. The recent recall problem had a negative impact on the company's bottom line, costing it $0.06 per share. The company has to improve its supply chain and manufacturing process to avoid such events in future. Kellogg has been replacing its plants in order to improve its operations, and it has anticipated a further $70 million cost for improving its manufacturing process.
Kellogg reaffirmed its full year guidance of 2% - 3% for internal net sales growth. Full year earnings per share are expected in the range of $3.18 - $3.30 for the company.
Margins trend turned out to be down YoY. This was mainly because of higher commodity costs, costs related to recall and an increase in investments related to brand building. However, we believe that margins for the company will improve in future as it overcomes its supply chain problems. Also, the company is spending on brand building which will help it to pass on the rising input cost to consumers and, eventually, help the company in improving its margins. The table below shows margins for 3Q 2012 as compared to 3Q 2011.
Gross Profit Margin
Operating Profit Margin
Source: Earnings Release and Qineqt's Estimates.
The company offers a decent dividend yield of 3.4%, which is backed well by an operating cash flow yield of 8.5% and a free cash flow yield of 4%. The table below shows dividend coverage for the last three fiscal years.
Operating cash flow less CAPEX
However, it has a high debt level of 385%, even higher than that of its competitor, General Mills . If we compare Kellogg with PEP, Kellogg seems to be slightly undervalued, based on its forward P/E of 15x.
General Mills, Inc.
Debt to Equity
Source: Yahoo Finance