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In the fall of last year, the former Kellogg's Company split up the business in two: Kellanova (NYSE:K) and WK Kellogg Co (KLG). The latter comprised a nearly $3 billion and somewhat troubled cereal business, and has been spun off by Kellanova as the remaining entity to improve the growth profile of the remaining $13 billion business.
Benefitting from a better positioning, Kellanova has been struggling somewhat itself as well with inflationary pressures, resulting in a poor composition of growth, although margins hold up rather well.
Trading at a slight discount to the market, driven by the fear about GLP-1 drugs, which have the potential to hurt its growth profile as well, I fail to be upbeat here as well, meaning that I hold a neutral stance here.
About Kellanova
Upon the time of the spin-off of the business in the fall of last year, Kellanova was a $13 billion business which generated $2 billion in EBITDA from a range of strong (snack) brands. This includes Pringles, Pop-Tarts, RX Bar and Cheez-IT, among others. Developed market snacks make up over half of sales, emerging markets make up nearly 30%, complemented by frozen and some (international) cereal activities left. In terms of geographies, the company is split just about 50-50 between developed and international market activities.
The company more or less aimed to replicate the success of snacking giant PepsiCo (PEP), another food company which has successfully managed to reposition the portfolio at various point in the past.
Pro forma operating earnings were seen at $1.75 billion, resulting in earnings of $3.35 per share for this business, with shares of Kellanova trading at $53 per share upon completion of the spin-off of WK Kellogg.
Trading at a relative reasonable 15-16 times earnings multiple, these valuations looked quite reasonable, yet of course there were some questions on the pro forma implications of the spin-off, mostly relating to stranded costs upon the completion of the spin-off. Moreover, some parts of the new business might become more challenges as well with the rise of GLP-1 drugs, which made me constructive on the shares, but I failed to have conviction.
A Modest Recovery
Shares, which traded in the lower-fifties in October, have recovered towards the $60 mark at the moment of trading, after trading in the lower-sixties recently.
In February, the company posted 2023 sales up nearly 4% to $13.1 billion, although that the company reported organic sales growth exceeding 8%, reporting adjusted organic net sales of $13.6 billion, with the difference mostly relating to divestment (of Russian activities). Adjusted operating profits rose by nearly 18% to $1.62 billion, resulting in low-double digit operating margins.
Adjusted earnings per share were reported, up some 9% to $3.23 per share. While the 8% organic growth number looked impressive, it was comprised out of a 12% price/mix effect and a 4% decline in volumes.
For 2024, the company guided for organic growth exceeding 3%, with adjusted operating profits seen between $1.85 and $1.90 billion, with adjusted earnings seen at a midpoint of $3.60 per share, plus or minus five cents. The company did not provide a leverage ratio, but net debt of $5.6 billion suggested leverage somewhere between 2 and 3 times EBITDA, if we add back depreciation expenses to the adjusted operating profits.
In April, the company announced a quarterly dividend of $0.56 per share, being the 398th dividend paid consecutively since 1925, with a century-long period of dividends being paid coming up later this year. Trading in the high-fifties, a near 4% dividend yield looks quite compelling.
Reasonable Execution
Early in May, Kellanova reported a 4% fall in first quarter sales to $3.20 billion, yet organic sales were up over 5% to $3.50 billion. Again, the composition of growth remains troublesome, with an 8% contribution from pricing and mix more than offsetting a continued 3% fall in volumes. That said, both price and volume trends are both reverting to the flat line.
Adjusted operating profits rose by a quarter to $508 million, with adjusted earnings up twenty-three cents to $1.01 per share, reported at $1.04 per share in constant currency terms. Net debt was pretty stable around $5.7 billion as the company reiterated the full-year guidance on all fronts.
Based on the current earnings guidance, the company trades at 16–17 times adjusted earnings seen this year.
What Now?
The whole debate about the GLP-1 drugs does not really have a near-term impact on the business. Trading at a roughly 6% earnings yield, the company trades at reasonable valuations, with debt firmly in check and growth reported. The problem is in the composition of growth, which is all driven by pricing, with volumes still coming down.
However, with inflationary pressures cooling off, Kellanova announced that it saw volume trends improve recently, at least that is what it said on its first quarter earnings call, with category-level elasticities starting to moderate. Continued network optimization might be a driving force of margins, on top of pricing, boding well for earnings to gradually improve to $4 per share, maybe not in 2025, but likely in 2026.
Given all this, Kellanova shares trade at fair valuations likely, as the appeal found in the lower fifties last fall has been largely gone following a 15% return in about half a year time, a decent move for a consumer package business. Right here, I am taking a wait-and-see approach toward Kellanova, before reconsidering a now neutral stance.
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