Kellogg's: The 'Growth Story' Continues To Unfold
Summary
- Kellogg's 6% revenue growth delivered in 2Q18 is the best in years, and about as exciting as it gets in this industry.
- However, significant cost of goods pressure continues to eat away at margins, this time resulting in flat op profits.
- High-quality, defensive stocks are worth keeping tabs on, although I favor General Mills in the consumer packaged foods space.
- Members of my private investing community, Storm-Resistant Growth , can follow this idea, as well as my other top picks with access to my model portfolio. Start your free trial today >>
Kellogg's (NYSE:K) plan to reverse more than five years' worth of declining revenue and dwindling profits continue to unfold.
This morning, the packaged foods giant delivered consensus-beating sales of $3.36 billion that rose the most YOY since at least 2013 - +6%, confirming for now the unlikely "CPG growth story" that I had referred to last quarter. Margin challenges prevented much of the moderate revenue upside from trickling down to pre-tax earnings, yet adjusted EPS of $1.14 topped expectations by two cents.
Credit: Food & Wine
On the results
Late 2017 momentum continued to build, this time lifted by two key international markets. Despite well-known pricing challenges and the 10-day Brazilian trucking strike in May, Europe and Latin America combined managed to offset revenue softness in North America (all on an organic, currency-neutral basis), which this quarter was more pronounced than in 1Q18. The top-line dynamic reinforced (1) the importance of Kellogg's globally-diversified portfolio that generated 47% of sales outside the U.S. vs. 43% last quarter, and (2) that demand for mass-produced packaged foods continue to be solid when marketed at the right price - i.e. cheaper.
Source: DM Martins Research, using data from company reports
Gross margins dipped once again, not surprisingly. In addition to the pricing weakness, the current macro environment of higher wages, commodities and fuel prices continued to pressure Kellogg's profitability. Producer price inflation is one of the most convincing bearish arguments that I can find against betting on packaged foods companies like Kellogg's, especially considering mid-teen op margins that are a bit too narrow to absorb the impact of increasing cost of goods.
Adjusted SG&A, on the other hand, dipped YOY by nearly 3%, helping to keep op income largely flat compared to year-ago levels. The operating leverage could have even been greater, in my view, if not for increased marketing spending needed for brand building and to push volumes up - which I believe is necessary to support the welcome top-line momentum. The operational results in the quarter align with my expectations that most of Kellogg's projected earnings growth in the near future will come from cost cutting. The greatest contribution to non-GAAP EPS increase of 17.5% YOY this time, however, came in the form of a significantly lower effective tax rate.
Below is the summarized P&L on a non-GAAP basis.
Source: DM Martins Research, using data from company's press release
On the stock
Kellogg's may have not impressed investors with today's results, but it certainly reinforced trends that look much more encouraging than they had in the past several years. Still, investing in packaged goods has its downside, especially when consumer prices are not quite strong enough to fight rising producer prices.
K PE Ratio (Forward) data by YCharts| Ticker/Company | Forward P/E | LT EPS Growth | Fwd PEG | FCF Yield |
| Kellogg - K | 15.7x | 8.3% | 1.9x | 5.8% |
| General Mills (GIS) | 15.0x | 9.0% | 1.7x | 8.3% |
| Mondelez (MDLZ) | 17.8x | 10.0% | 1.8x | 3.8% |
I continue to pay attention to high-quality, defensive stocks as they tend to serve as a good balance for investment portfolios that are too heavily tilted toward growth names or those in highly pro-cyclical sectors (e.g. tech). In that regard, K could be a name worth consideration. However, within this space, I continue to favor GIS and its lower valuations, higher earnings growth prospects with the recent acquisition of the pet food business, and stronger free cash flow-generating abilities.
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This article was written by
Daniel Martins is a Napa, California-based analyst and founder of independent research firm DM Martins Research. The firm's work is centered around building more efficient, easily replicable portfolios that are properly risk-balanced for growth with less downside risk.
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Daniel is the founder and portfolio manager at DM Martins Capital Management LLC. He is a former equity research professional at FBR Capital Markets and Telsey Advisory in New York City and finance analyst at macro hedge fund Bridgewater Associates, where he developed most of his investment management skills earlier in his career. Daniel is also an equity research instructor for Wall Street Prep.
He holds an MBA in Financial Instruments and Markets from New York University's Stern School of Business.
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On Seeking Alpha, DM Martins Research partners with EPB Macro Research, and has collaborated with Risk Research, Inc.
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Analyst’s Disclosure: I am/we are long GIS. 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.
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