kellogg's company paper
TRANSCRIPT
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By Eoin Moran
Table of Contents1. Executive Summary..............................................................2
2. Overview...................................................................................3
3. A History of Strong Corporate Governance............................................3
4. Ownership and Current Management..................................................4
5. Rewarding Shareholders.................................................................4
6. Competitor Analysis..................................................................5
7. Medium Term Outlook...................................................................6
8. Quantitative Ramifications..............................................................7
9. Analyst Opinion...........................................................................9
10. Final Reccomendation....................................................................9
11. Appendices..............................................................................10
12. Bibliography.......................................................................13
1
Reccomendation: Long Hold Project X to have positive
impacts
Stalled innovation a
concern amid sluggish
cereal sales
Rising debt levels are
concerning
Competitive Landscape
High level of deal activity as organic growth opportunities
remain low
North America packaged food sales continue to stall
Reliance on Walmart Stores Inc. (WMT) as key customer
poses risk
Dividend Growth (2011-2016)
Continual
annual
dividend
growth a key
element of
K’s appeal to
shareholders
13 years of successive dividend growth
Source: Bloomberg Terminal
Object 2
Overview
Kellog Co. (Ticker: K) is the eight largest North American packaged-food company based on sales (Appendix 1).
It supplies ready to eat cereals and snacks to over 180 countries (Bloomberg, 2016). Historically it has been
solely a member of the dry cereal industry holding well-known names in the industry such as Corn Flakes and
Special K. Kellogg’s is a member of the “North American Packaged Food Industry”; primarily the ‘U.S Cold
Cereal Market” and the “Global Snacks Industry”. K’s current stock price as of 21 November 2016 is $73.39.
A History of Strong Corporate Governance
Over its long history Kellogg’s has always self-identified as a company of the highest moral and ethical
standards. In a recent interview, current CEO John Bryant, referenced Kellogg’s founder W.K Kellogg, his work
as a philanthropist, and how Kellogg’s as a company aims to embody the value of its founder(Youtube, . These
values are outlined in the company’s 56 page “Global Code of Ethics”, which was most recently updated in
2013. The doctrine is based around 6 key values (integrity, accountability, passion, humility, simplicity) and 5
core principles which outlines the company’s responsibility to their key stakeholders (our people, our
consumers, our marketplace, our investors, our communities).
Most recently, In 2014, Kellogg announced new global sustainability goals in responsible sourcing and
the conservation of natural resources. The company also continued progressing against its hunger relief
pledge to donate 1 billion servings of food through Breakfasts for Better Days.
Kellogg’s has featured on Ethisphere’s “World’s Most Ethical Companies List” each year since 2011
(Ethisphere, 2016); though the legitimacy of this list has been called into the question in the past (Evans,
2016). The company’s efforts has also been noted on Wall St. In 2014, The Street lauded their efforts to utilize
corporate social responsibility in a profitable manner (Courtenay, 2014).
KELLOGG CO. – NOVEMBER 2016 2
Ownership
Kellogg’s ownership structure is unique and is closely linked to their founder, W.K. Kellogg. The company’s
largest shareholder, at 19.5%, is the W.K Kellogg Foundation; which was established in 1930 to promote the
welfare of children (Figure 3). As a result of their unique structure, Kellogg’s is one of the few industry leaders
not publicly targeted by activist shareholders in recent years. Taken in the context of the industry this is
somewhat surprising as net income has declined by ~3% since 2010. (Bloomberg, 2016)
Current Management
John Bryant became President and CEO of the company in 2011. On July 1 2014 he added the responsibilities
of chairman of the executive board thus creating a situation of dual leadership. In spite of this, the market
reacted positively to this news, illustrating that he is liked by shareholders (the market marginally ticked
upwards (+0.45%) the day this was announced). Bryant is highly valued in the firm, having joined the company
in 1998. He also currently sits on the Macy’s board of directors. The company is currently without a CFO after
the retirement of Ronald Dissinger in May 2015, the search for a replacement is “ongoing” (Kellogg’s Investor
Relations, 2016).
Rewarding Shareholders
In the medium term, shares have generated a total return of 91% since 2010, marginally underperforming the
S&P 500 (95%) for the same period. Historically, stock splits and dividend payouts have been the primary ways
in which Kellogg’s has created value for its shareholders. The company has undertaken seven 2:1 stock splits in
the past, with the most recent of these occurring in 1997. Certain analysts have touted that they expect
Kellogg’s to undertake another stock split in the near term (Caplinger, 2016).
KELLOGG CO. – NOVEMBER 2016 3
Dividends have been increased on an annual basis every year since 2003, a trend which has continued
into 2016. These consistent, gradually growing, long term returns are valued by institutional investors as
65.5% of the company is owned by this investor class. This steady rise can be seen in Appendix 6.
Competitor Analysis
Per Bloomberg GIC’s classification Kellogg’s is a member of the ‘North American Packaged Food Industry’, of
which it holds a 4.6% share; down from 5.3% in 2011 (Appendix 2). It is the market leader of the ‘U.S. Cold
Cereal Market’ subindustry holding a 32.2% share in 2015 (Bloomberg, 2016). Kellogg’s nearest competitor
within the industry is General Mills. Kellogg’s currently holds just 1 of the top 5 most popular cold cereal
brands, with General Mills holding the other 4. (Appendix 3). This industry has performed poorly in recent
years due to waning consumer demand for cereal products. All types of cereals have slumped significantly in
recent years with the exception of muesli (Appendix 4). As a result of this fall in cereal sales Kellogg’s has
shifted long term strategic direction in recent years with a focus on capturing market share from the highly
competitive but lucrative Global Snacks industry which is dominated by market leader Pepsi Co. (29.0%). Per
Bloomberg, Kellogg’s has been successful in increasing its share of the industry which has grown from .67% in
2011 to 2.38% currently (Appendix 5).
Analysis of the Packaged Foods Industry competitive landscape highlights significant M&A activity
among K’s competitors. This search for inorganic growth suggests that the opportunities for organic growth
are limited. Kellogg’s however, has historically relied on internal product development to fuel growth. In spite
of this fact, K’s R&A spending is in line with competitors. “Kellogg's research & development spending as a
percentage of sales of 1.4% is in line with that of its close competitors Campbell Soup (1.5%), General Mills
(1.3%) and PepsiCo (1%) (Bloomberg, 2016). failure to invest while others are growing inorganically means the
company could lose market share. The one divergence from this strategy has been the recent, somewhat
minor acquisition, of Brazillian salty snack firm Parati, in October 2016 (Reuters, 2016)KELLOGG CO. – NOVEMBER 2016 4
Medium Term Outlook
Kellogg’s to be impacted as US Cold Cereals Industry Continues Decline
For almost a century, Kellogg’s defined the American breakfast. However, this landscape has been changing.
Consumption of cold breakfast cereals has been dropping at a rate of 1% per annum for the last decade
(Stealing Shares, 2015). Consensus predictions place cold cereal sales to fall at a rate of as much of 2%
annually (Bloomberg Terminal). This shift in demand has been caused my millennials favoring healthier, more
convenient options. Although, the cold cereal market industry is a historically moderately growing sector, this
negative growth rate is unprecedented.
The Company announced in late June it will introduce more than 40 new products to its U.S. cold
cereal lineup this year that will match trends linked with both nutrition and convenience. A key focus will be
on producing organic products. Special K Multigrain Crackers with Quinoa and MorningStar Farms® Veggie
Breakfast Sausage & Grain Patties are two of their newest releases and underline this trend (Kellogg’s
newsroom, 2016). The growth in the number of products and market share is one of the company’s key
drivers in the medium term (Appendix 7)
None of these products have yet gained any serious traction suggesting the company is stifled by a lack
of creation. There is every indication that this is an industry which will continue to decline and Kellogg’s may
miss out as millennials become a key demographic.
Project K to Offset This in the Medium Term
I anticipate project K, Kellogg’s flagship cost saving scheme, begins to reap the rewards it has promised. This is
a flagship strategy which Kellogg’s has pushed onto shareholders. Management have stated that current
expenditure cost saving will be in the region of $450-500 million (Appendix 6). This will primarily be achieved
through the consolidation of factories and production lines. This will also lead to significant reduction in capital
KELLOGG CO. – NOVEMBER 2016 5
expenditures as expenditure on the scheme tapers (currently Project K accounts for 75% of capital
expenditure) and reductions in expenditure. This will have obvious implications on net income.
Project K has already had success indicating future successful implication is probable: As a 2014 CNN
article outlines; “The Eggo factory recently installed "fuel cell technology" that supplies half of its annual
energy needs and consumes less water than it would if it were connected to the energy grid.” (Rooney, 2014)
Kellogg’s Recent Borrowing Inflates Debt Leverage
Kellogg’s most recent debt leverage, as measured by 12-month total debt-to-Ebitda was 4.5x at the end of
3Q16. This is far higher than its unadjusted level over the past 5 years (4.1x).This represents a significant 31%
increase in debt driven by the minor acquisition of Parati, and costs associated with Project X. Looking
horizontally, debt leverage in the farm far exceeds that of its closest rivals (General Mills (2.7x) and PepsiCo
(3x)). A major question arising from this is whether Kellogg’s can afford to increase its dividend payout despite
its somewhat worrying debt situation.
Quantitative Ramifications
Income Statement
Revenue
2016 - 2019 1.5%
Assume low demand for cereal sales continues, however it can be anticipated that growth in Asia/Pacific
continues leading to a modest increase in overall revenue.
Gross Profit Margin
Assume increasing use of costly new ingredients (e.g -quinoa) to support product innovation is not sustainable
given they have so far not been met by sales growth as anticipated.
KELLOGG CO. – NOVEMBER 2016 6
Operating Expenses
Efficiency to improve as a result of Project K rollout. Assume operating costs to begin falling through the
remainder of 2016 and into 2017 to the amount predicted by management of $475 million by 2019.
Translating to a $120 million fall in operating expenditure. 120/3500 = -3.5%
Merger/Acquisition Expense
Assume no activity as K maintains current strategy of focus on organic growth through internal innovation.
Cash Flow
Depreciation
Consolidation of factories and production lines to reduce the amount of fixed assets as well as the depreciation which
those fixed assets would incur. Reducing the number of factories through consolidation will thus inevitably push
depreciation associated costs down. To fall in line with the reduction in capital expenditure due to Project K,
anticipate depreciation will fall by 3% annually.
Working Capital
Assume working capital will increase in line with how the industry is moving. K has increased working capital in
5 of the last 7 years. The mean of these 5 increases has been 3% and there is a strong probability that the rate
of increase will be in line with this rate. I assume this is a trend that will continue as K looks to continue look to
increase flexibility across the business model.
Disposal of fixed assets
Anticipate the consolidation of processes outlined in Project K will lead to greater revenue from the disposal of
fixed assets.
KELLOGG CO. – NOVEMBER 2016 7
Balance Sheet
Total Assets
Consolidation as part of Project to lead to an overall fall in level of fixed assets; higher ROA as a result.
Debt
Total debt to fall in line with changes in assets. Future debt levels to fall as Project X spending tapers.
Inventories
Inventories will rise at a slightly higher rate (Currently 4%) due to increases in product innovation and a shift
towards higher quality ingredients.
Analyst Opinion
Shares of Kellogg Co. have been given a consensus recommendation of “Hold” by the nineteen ratings firms
that are covering the firm. One research analyst has rated the stock with a sell recommendation, thirteen have
issued a hold recommendation and five have assigned a buy recommendation to the company (Bloomberg
Terminal, 2016). Many analysts cite Project K as a key determinant in their buy rating. However, despite a
reasonable level of confidence in Kellogg’s management. It is hard to believe Project X alone is sufficient to
overcome the serious structural faults in the cereal market, of which Kellogg’s is so defendant.
Final Recommendation
A major question currently facing management is whether they can continue the trend of raising dividends in
spite of the increased debt as a result of project X. Failure to do so could seriously hamper company
reputation and medium term prospects. My HOLD recommendation is largely formed from the assumption
that Kellogg’s strong management team will continue to increase dividend payout to shareholders and will
work to reduce debt levels upon the completion of Project X. It also imperative that they build on growth
within the global snack industry, amid weaknesses in their primary market; cold cereals market.
KELLOGG CO. – NOVEMBER 2016 8
Appendices
Appendix 1: North America Packaged Food Industry – Market Share by Sales (2011-2016)
Source: Bloomberg Terminal
Appendix 2: Breakfast Cereal Sales – Change in Consumption (2003-2013)
Source: Euromonitor (http://www.euromonitor.com/breakfast-cereals)
Appendix 3: Largest Cold Cereal Brands – 4Q16
KELLOGG CO. – NOVEMBER 2016 9
Source: Brandon Gaille (http://brandongaille.com/27-stunning-cereal-industry-trends/)
Appendix 4: The Kellogg Co’s Largest Shareholders (As of 18 November 2016)
Source: Bloomberg Terminal
Appendix 5: Historical Stock Splits
Source: Kellogg’s Investor Relations (http://investor.kelloggs.com/stock-information)
Appendix 6: Dividend Growth (1965-2015)KELLOGG CO. – NOVEMBER 2016 10
1965 1975 1985 1995 2005 20150
0.5
1
1.5
2
2.5
0.03 0.09
0.23
0.75
1.06
1.98D
ivid
end
($)
Source: Data taken from Kellogg’s Investor Relations (http://investor.kelloggs.com/dividends#chart)
Appendix 7: 2020 Growth Plan
Source: Kellogg’s Investor Relations (http://investor.kelloggs.com/stock-information)
Appendix 8: Project K Outline
KELLOGG CO. – NOVEMBER 2016 11
Source: Kellogg’s “Visibility into the future presentation (Slide 72) (http://investor.kelloggs.com/~/media/Files/K/Kellogg-IR/reports-and-presentations/2016/2016-cagny-presentation.pdf)
KELLOGG CO. – NOVEMBER 2016 12
Sources
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Retrieved on 16 Nov. 2016 from https://www.youtube.com/watch?v=m0JXiMjpvbE
2. "Honorees". Ethisphere Institute | “Good. Smart. Business. Profit.” N.p., 2016. Retrieved on 16 Nov.
2016 from http://worldsmostethicalcompanies.ethisphere.com/honorees/
3. Evans, Will. "Beware Of Corporate Consulting Firms Offering Awards For Corporate Ethics.". Slate
Magazine. N.p., 2016. Retrieved on 16 Nov. 2016 from
http://www.slate.com/articles/business/moneybox/2010/03/its_all_good.html
4. "Kellogg To Buy Controlling Shareholder Of Brazil's Parati Group". Reuters. N.p., 2016. Web. Retrieved
on 19 Nov. 2016 from http://www.reuters.com/article/kellogg-ma-ritmo-idUSL4N1CJ3QN
5. "Breakfast Cereal And The Breakfast Food Market - Stealing Share". Stealing Share. N.p., 2016. Web. 21
Nov. 2016 from http://www.stealingshare.com/pages/breakfast-cereal/
6. "Kellogg's Recipe Of Ethics, Social Responsibility Feeds Profits". TheStreet. N.p., 2016. Retrieved on 21
Nov. 2016 from https://www.thestreet.com/story/12537553/2/kelloggs-recipe-of-ethics-social-
responsibility-feeds-profits.html
7. Rooney, Ben. "Kellogg Co. Is The Second Big Cereal Company To Unveil New Sustainability Goals"
CNNMoney. N.p., 2016 Retrieved on 19 Nov. 2016 from
http://money.cnn.com/2014/08/13/news/companies/kellogg-sustainability-goals/index.html?iid=EL
8. "Kellogg U.S. Brands Launch New Delicious Breakfast And Snack Choices". Kellogg Company News
Room. N.p., 2016. Web. Rettrieved on 21 Nov. 2016 from
http://newsroom.kelloggcompany.com/2016-05-02-Kellogg-U-S-Brands-Launch-New-Delicious-
Breakfast-and-Snack-Choices
KELLOGG CO. – NOVEMBER 2016 13
9. Caplinger, Dan. "Kellogg Stock Split: Will The Food Giant Split Soon? -- The Motley Fool". The Motley
Fool. N.p., 2016. Retrieved on 18 Nov. 2016 from http://www.fool.com/investing/2016/11/15/kellogg-
stock-split-will-the-food-giant-split-soon.aspx
Additional Resources Used
1. Bloomberg Terminal
2. "Investor Relations". Investor.kelloggs.com. N.p., 2016. Web. Domain accessed on 15-22 Nov. 2016.
KELLOGG CO. – NOVEMBER 2016 14