Kellogg: Can It Recover?

| About: Kellogg Company (K)
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Kellogg Company's (NYSE:K) stock isn't one that can provide immediate returns. The company is under the "slow growth" category and therefore requires patience if one seeks to earn a premium. The recent fiscal year 2013 end brought static returns to investors implying an unwavering atmosphere for the company's operations. In this article, I am going to analyze these operations. Also I will analyze the internal improvements the company is making that will help it to grow its share value that has stayed the same despite being volatile year to date.

The Year

Source: Presentation

The company's net sales for 2013 increased by 4.2% to $14.8 billion in 2013 with an internal growth of 0.3%. The table above shows the revenue trend. Pricing was favourable but lower volumes brought down the internal growth rate. A huge part of the sales (4.6%) increment came from the recent acquisitions and divestments the company has completed.

I believe these acquisitions are a smart move as they fit perfectly under the company's product portfolio. For example, the Pringles brand that Kellogg acquired for $2.7 billion in 2012 has given above expectations sales and profit growth in every quarter since the transaction became secure. For the full year, the chips delivered high single digit internal sales growth that was double during the last quarter alone. With the company bringing additional flavors and keeping the image alive it is likely that such acquisitions will continue contributing significant additions to revenues in the future.

The gross margin declined slightly more than 1% to 39%. Inflation in cost of goods of 100 bps points together with lower operating leverage were key drivers of the declining performance that resulted in a 70 bps drop on a comparable basis. Pringles also impacted the margins by nearly 40 bps owing to integration costs.

Source: 10K

Reported operating profit increased by 81.6% to $2.8 billion however excluding the currency and acquisition impact the underlying internal operating profit increased by 1.3%. According to the table above, we can see that excluding US breakfast foods and snacks, all segments reported positive comparable growth in profit with Asia leading the way. This depicted a good picture of how the company's internal efficiencies and acquisition of brands continue to provide growth from international boundaries at a higher rate than the US.

After excluding comparability issues the EPS increased 4.4% to $3.8 over the full year. All in all, 2013 was stable with the company taking several steps to ensure their future remains prosperous. This included cost-saving initiatives through the K program, reducing debt levels, initiating a share repurchase program, and integrating acquisitions into the company's long-term strategy.

The K-program

This initiative was launched last year and is a 4-year program that will transform the company's internal operations bringing efficiencies that will drive profits higher in the future. For starters, the company is reducing its workforce by 7%. Additional features will target the supply chain infrastructure and ensure a more global focus; these bring costs savings of $425 to $475 million beginning 2018. However, prior to that, the company will incur charges nearing $1 billion ($350 million average for 2014) over the course of the program that might depress profits in the short run.

This program was crucial for the present industry environment where internal cost efficiencies might be the sole reason behind stealing industry returns. This and the focus on leverage mean Kellogg's management is in the right direction to develop sustained returns.

Reducing the Debt Level

Kellogg presently operates at a debt/equity of 1.8 that is higher than the industry's 1.0. Since higher debt raises concern of the company's ability to repay debt and possible downgrading by rating agencies it will consequently force the organization to borrow at higher rates that impact profits. The company's ongoing plan to lower its debt will finally pay off in the longer term after the D/E comes in line with the industry. Kellogg has already removed $900 million from its debt in the last 18 months and I believe with the ongoing progress the company will be able to bring its debt in line to that of market within 5-10 years.

This, in turn, will help the company to stand strong in uncertain times when sustaining profitability becomes challenging.

Share Repurchasing

Kellogg also purchased $544 million worth of shares in 2013. For 2014, it will reduce the overall average share count between 1.5% and 2% by carrying out additional repurchases. This will further strengthen the company's leverage ratio as reducing debt and increasing equity together will work to get the D/E down at a faster pace. Moreover, buying back shares will be a good use of the company's cash sitting idle after it is done with spending on the Pringles development and the opening of new plants such as the one in India.


Kellogg continues to integrate its acquisitions under its portfolio. Last year, the company incurred $0.13 per share as costs related to Pringles. We can wait until the company gets synchronized to deliver its true potential. I'm not saying that Kellogg has lagged behind in the past because it delivered a net margin, ROE, ROE and income growth all above the industry average last year with a moderate performance. However, the K-program and other initiatives make me more confident in the company's good future. Therefore, I give it a long-term buy rating.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.