The central theme of Kellogg's (NYSE:K) recent quarterly earnings call was how many of its big brands have started to turn the corner and grow. Popular brands such as Pringles, Cheez-It & Rice Krispies Treats all seem to be on an upward trend which is significant. Another brand - Special K also saw more stability in the second quarter. Management had been harping on about how productive marketing in relation to its health benefits could move the needle here so we maybe starting to see fruit as declines have moderated
With the cereal producer now at mid year stage, analysts have been taking stock at how much the top line has moved in the first two quarters compared to the same 6 month period of last year. The main reason obviously has been the acquisitions although top line organic growth has still grown by 4 quarters in a row now. When we strip out the acquisitions though, the question is whether Kellogg will be able grow that top line in this present fiscal year.
Management reiterated on the call that it doing everything it can on the cost side to offset the obvious inflationary pressures which are coming down the track. Remember shares have been on a tear over the past 3 months and Q2's recent numbers don't look like they will halt present momentum.
Management also cited that top line growth is coming to a large extent from the renewed efforts by management to invest behind its brands. The move to the warehouse model definitely has helped more innovation and investment behind its brands and finally we are seeing this in the numbers. Management has to be applauded for this as it paved the way for more aggressive brand spend in what has come a fiercely competitive market.
Kellogg now trades with a book multiple of 8.7 which looks a little on the light side when compared to its 5 year average of 9.8. However, with any potential long play, the viability and strength of the company's dividend is a must. Top line sales are expected to grow by 4.5% this year and earnings are expected to increase by about $0.46 per share. These numbers on their own should move the needle for the share price. We though are continuing our stance with respect to looking for defensible stocks as the market continues to grind higher. This makes the dividend key. Let's see how Kellogg's dividend shapes up at present.
Kellogg's yield now stands at 3.19%. The company has successfully raised its dividend for the past 13 years. The most recent increase has already been declared and will be $0.56 per share per quarter. Kellogg in fact goes ex-dividend at the end of this month where the increase will be $0.02 over the former pay-out of $0.54. This gives us a 3.7% dividend growth rate over the past 12 months.
To be honest, we would be looking for more. The 10 year US bond now yields 2.8% and you feel it will only rise from here. If investors want to see what the dividend growth rate is like over the past five years, we can see that it comes in at around 4%. Again, in an interest rate environment, when the dividend yield is close to to what investors can get from fixed term investments, then one has to rely much more on capital gain in the share price.
Free cash flow generation is obviously a key metric for dividend growth. Management decided to contribute $250 million to the pension which hurt cash flows in the second quarter. However, if we go over the last four quarters, we can see that approximately $747 million was paid out in dividend payments and $936 million was generated in free cash flow. This gives us a pay-out ratio of 80% which doesn't leave much scope for robust dividend increases. The bulls will say that the last 4 quarters is not a suitable reporting period due to the pension contribution and the accounting changes of last year. However, we go by the numbers and its looks like more of the same here.
When a company reports profits, it can pay down debt, issue a dividend or even a special dividend, reinvest in the business or buy back shares. Personally we prefer a bit of each. In Kellogg though, shareholder equity and debt seem to be diverging (in the wrong way) and shares outstanding has not come down that meaningfully in recent times. So to really get paid from Kellogg going forward, one would need to see sustained revenue growth as well as consistent bottom line earnings beats. There is still not enough downside protection for us here at present so for the time being, we will give Kellogg a pass.
