Like many value stocks, Kellogg Company (NYSE:K) has been more compelling in recent years thanks to dividends rather than rising prices. Still, there are some interesting angles on the title that could see it go from a loser to a winner against the broader market going forward, and Kellogg is definitely worth watching.
Why Kellogg Might Be Worth Watching
Over the past few decades, the Kellogg Company has built up an extensive portfolio of well-known brands around the world. This is reflected in their ranking among the top 100 global brands, where they currently sit at 72nd. Here are some of their strongest brands:
In addition to brand strength, Kellogg’s products also benefit from a high degree of independence from economic cycles. People will always eat breakfast, regardless of their financial situation.
This continuity is particularly evident in the history of dividends. The Kellogg Company has consistently increased its dividend over the past 17 years. In fact, the dividend has not been lowered in the past 32 years.
With a current payout ratio of around 53%, the dividend is sustainable and leaves ample room for investment. They recently used it to invest $43 million to expand their MorningStar farms as the plant-based food market continues to grow.
Unlike dividend history, price history has been poor in recent years. The stock has been in a sideways trend for years. Comparing the total return of the S&P 500 to the total return of Kellogg stock shows that Kellogg’s value has remained virtually unchanged over the past five years, while the value of the S&P 500 has more than doubled.
Nonetheless, there have always been phases in the past when an investment in Kellogg would have paid off. Especially in weak economic phases, the Kellogg’s price crash has been less than the market crash as a whole. Therefore, stocks could be used to hedge a portfolio.
Watch key metrics
In order to be able to make a plausible assessment of the Kellogg company, I will first assess the company’s financial situation. The following figure shows the key figures underlying Kellogg’s corporate income statements and balance sheets for the past five years. Figures for 2021 are taken from the last four quarters of 2021 (Q1 to Q4).
The figure shows that the Kellogg company has not been able to achieve great growth in recent years. Sales increased by an average of 2.58% per year; EBIT has been trending sideways since then. Net profit for the year increased by 4.67% annually due to the strong results of 2021. Thus, I would currently describe the Kellogg company as a slow growing company.
To continue with profitability, the Kellogg company has solid measures. The average net profit margin was 9.25% and is therefore significantly better than the industry median (5.22%). Although the return on equity (RoE) seems very high at an average of 39.62%, it is the result of a low equity ratio. Therefore, I prefer the return on capital employed (ROCE), which averages 13.27% for the Kellogg company and also suggests good profitability.
Finally, the risk is assessed. Gearing has steadily decreased in recent years and the equity ratio and the net debt/EBIT ratio have steadily increased. The situation is therefore improving from the point of view of risk assessment. The numbers still aren’t exactly good, but they aren’t scary either.
All in all, we can sum up that the Kellogg company is no longer making much progress, but is posting good profitability in sectoral comparison and the risk situation is improving.
To arrive at a valuation of Kellogg shares, I will first make some estimates. For sales, I assume a conservative annual growth of 1.7% per year. Due to a historical net profit margin of 9.25% on average, I have set this value at 8.0% for the future. In order to be able to estimate the future free cash flow, I compare the values reached in the past with the net result. I derive a ratio of 1:1 for my estimates. This results in the following rather conservative estimates:
The figure below shows the discounted cash flow model based on the estimates. A sensitivity analysis was also performed considering different values for the market risk premium and the long-term growth rate.
Thus, using relatively conservative assumptions, the fair value per share is $65.23, which is quite close to the actual value at the time of valuation. So, in my opinion, the title is currently quite valued.
In principle, the Kellogg share is a defensive stock and therefore presents little risk at the expense of growth. One such risk is the trend towards healthier lifestyles, which could affect the entire industry. Products containing sugar present a particular risk and could at least be avoided by part of the population. On the other hand, regarding the downward trend in meat consumption in some parts of the world, for example in Europe, the Kellogg company is very well positioned with its meatless products.
Since Kellogg operates in the food industry, climate change is another risk that could spell trouble for the company. Crop failures due to climate change could lead to production losses and therefore reduce sales and profits from time to time in the short term.
I see the loss of brand value as another risk. Trademarks represent the moat of the Kellogg Company and contribute significantly to the security of the business model. However, according to Interbrand statistics, the brand value of the Kellogg company has been declining rapidly since 2014. Nevertheless, this should be viewed with some skepticism, as a brand that has been built on a century will soon die out.
In summary, Kellogg is a solid company that I don’t expect to see much growth in the future. An investment can still make sense to protect a portfolio against economic risks, especially in an inflationary environment such as the one we are currently experiencing. Kellogg will be able to pass on price increases to customers through its strong brands. Many do not like to go without their favorite breakfast or snack. Profitability aside, the metrics are disappointing, but Kellogg is currently trading at fair value. One benefit is the steady and rising dividend, which has been, and likely will be, a small compensation for the lack of stock price gains over the past few years.
Overall, I rate the Kellogg Company as a “hold” due to the fair valuation. With better growth prospects, there could also be a “buy” classification in the future, which is why I’ll keep Kellogg on my watch list.