Kellogg (NYSE:K) is a member of the sainted consumer staples stocks which have a dividend. The stock is up 20% in the last 12 months even as the company just provided a weak sales outlook. This is the environment investors have to acknowledge. The narrative is investor's only option is to put money in stocks because fixed income provides low yields. Since we are in an earnings recession, the only logical place to put money in the market is consistent dividend payers. Investing in expensive value companies has been deemed more acceptable than buying stocks in growth companies which aren't growing.
Because investors view a stock like Kellogg to be a "blue chip", they don't consider the possibility it is in a bubble like the rest of its peer group. The reality is its results have been weak and its valuation doesn't reflect this. The question as to where the stock will go has nothing to do with the company itself. If the fundamentals mattered, a weak sales outlook would mean a stock price swoon of more than 5% considering its recent run.
Kellogg's stock price is determined by the length the low interest rate environment lasts. This is impossible to determine. Bubbles, whether it be in housing, technology or now bonds, tend to last more than anyone expects. There's a reason investors bought real estate expecting it to go up forever; it had been going up consistently for years. As someone who appeals more to the Austrian economic philosophy, I blame government actions for these bubbles. It's not much of a stretch to see how central banks are causing the bond bubble. Traders who buy negative yielding bonds are trying to make a quick profit by front running central bank buying.
The other factor keeping Kellogg stock higher is the in-between nature of the economy. Earnings have declined for 5 consecutive quarters, but the economy is not yet in a recession. The 1% growth rate economy in the 1 st half of the year, looks to be permanent, but as historical precedent shows, the economy will probably fall into a recession or (the less likely scenario) re-accelerate. In the former scenario all stocks will fall and in the latter scenario there will be a rotation towards growth and away from dividend stocks.
We are currently in the 'extend and pretend' phase of the economic cycle. Credit cycles usually last 5.5 years with the longest one lasting 7 years. This one has lasted 6.5 years, so far. This means it is long in the tooth. Default rates are above the average and recovery rates are the lowest in history. This signals the start of a new stress portion of the credit cycle.
The company's results are clouded by currency problems especially with the hyperinflation in Venezuela. It lowered full year GAAP EPS to $3.58-$3.65 from $3.64-$3.71 which gives the stock a 23 PE. With the low long term growth rate of under 6%, it gives the stock a PEG of 3.93 which is excessive as I would like to see it closer to 2. On a non-GAAP basis, which ignores the currency moves, earnings guidance was $4.00-$4.07 and is now $4.11-$4.18. However, more importantly, currency neutral sales growth for 2016 is expected to be from 4%-6% with the company now expecting it to be in the low end of that range.
Kellogg has a long term generational problem with its products. Firstly, while some of its brands like Kashi go after the health conscious consumer, products like pop-tarts aren't healthy even if the company has launched whole grain pop-tarts. Most of the brands owned by the company are brands created with a different generation in mind. Since millennials have different values, the company will be on the defensive with most of its brands.
The 'elephant in the room' which epitomizes millennials rejecting some of Kellogg's brands is the decline in cereal. As a millennial myself, I can't believe this trend as I eat cereal for breakfast almost every day. This trend is different from the Greek yogurt trend which I've certainly participated in. Either way, cereal sales have declined from $13.9 billion in 2000 to around $10 billion in 2015. Special K and Rice Krispies Treats each make up $200 million in sales which represents about 12.5% of total sales. The reasoning for this decline is surprising.
According to a 2015 Mintel survey, 40 percent of the millennials said cereal was an inconvenient breakfast choice because they had to clean up after eating it. They like eating breakfast on the go, if they have it at all. There may be a switch from cereal because a lot of the brands have too much sugar. Even Raisin Bran isn't healthy. According to the Today Show, it's ranked in the top 5 unhealthiest cereals because it has 19 grams of sugar.
As you can see Kellogg is constantly chasing consumer trends instead of being proactive. It's difficult to react to a change in taste that wholly rejects a category of its products. Either way, I don't see Kellogg accelerating its growth rate anytime soon. Normally, this would be ok, but with the stock having an expensive valuation, it's time to avoid it.
Kellogg has opened a cereal bar in New York City. The company said it got 1 billion impressions. I don't see how this will affect the decline in cereal eating among millennials. Millennials aren't avoiding cereal because they aren't aware of Kellogg's brands. They are avoiding them because it is difficult to clean up, isn't portable, and many brands aren't healthy.
The reason why the stock has done so well over the past 12 months is because the economy is in an uncertain low interest rate environment which is perfect for dividend stocks which aren't cyclical. As an investor, I would rather buy the stock which is going up because of the company's merit. This is a sustainable. No one knows how long this current paradigm will last, but it temporary, meaning Kellogg will once again go out of favor at the Wall Street fashion show.
Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.