In 2012, Kellogg sold $14.1 billion worth of cold cereals, cookies, crackers, waffles, snack bars, pastries, and those Lord-knows-what things you put into a toaster. In 2013, Kellogg sold $14.7 billion. In 2014, Kellogg sold $14.7 billion. And, over the course of 2015, Kellogg is expected to sell $14.7 billion worth of its food. The revenue growth has been sluggish, and absent a large buyback program to act as a countervailing force, this explains why Kellogg does not get nearly as much coverage as other companies in the blue-chip sphere.
On conference calls, Kellogg executives have described the breakfast tastes of Americans (who contribute $950 million towards the $1.4 billion in annual profits at Kellogg) as “evolving.” In plain English, Americans aren’t tearing down the aisles for more cereal year after year, and General Mills, Nestle, and the discounted store brands have proved to be worthy competitors. And it shows: Between 2007 and 2015, Kellogg has only managed to grow its profits from $1.1 billion to $1.4 billion. Ideally, I focus on blue-chips that double their profits every 7-8 years (or pay out a substantial dividend simultaneously to simulate the same effect), and Kellogg’s profit growth only amounted to a total of 27% cumulatively since 2007.
Unlike most companies that sell food, Kellogg does not receive a favorable credit rating from the agencies. Its debt is labeled BBB- stable, and if it were to fall one notch, it would no longer be considered investment grade debt (which would mean that many pensions and endowments and charities could no longer buy Kellogg debt as part of their charter, and the elimination of this pool of creditors would raise Kellogg’s borrowing costs). The reason why Kellogg enjoys such little love from creditors is not because the quality of its cash flows is suspect, but rather, its debt to equity ratio is 1.8 (nearly twice the debt-to-equity levels of its competitors like Unilever, Nestle, and General Mills). The total debt burden is $7.6 billion, and the company is low on cash, with only $426 million in hand.
On the other hand, I am one of those writers that distinguishes between buying and holding, especially when there is reason to believe that a higher growth rate for the company will eventually come. Kellogg has been riding the struggle bus before—it was paying out $1.01 in dividends while only making $1.31 in profits, for a 77% payout ratio. Back then, the company had to freeze the dividend from 2001 through 2004 to allow profits to rise to $2.16 before once again rewarding shareholders with more cash. And yet, someone who owned Kellogg stock from 2001 through February 2015 would have achieved 9.2% (compounding his money in a nice way while having an ownership interest in an easily understandable business that does not cut its dividend).
To get an idea of what Kellogg stock can do over the truly long-term, check out this 1996 article in the LA Times following the death of Agnes Plumb: “Few Knew She Was Wealthy—Until She Left $98 Million.” She definitely had some unique wiring—she tore up pictures of herself, wouldn’t invite guests inside because of her legs, and preferred to communicate exclusively through handwritten mail—but she also understood the power of holding onto stock in a business of spectacular quality. Her dad bought Kellogg stock, which she held and allowed to compound for five decades. By the time she died, she owned 1.3 million shares of Kellogg and was collecting $437,000 quarterly dividends. And keep in mind those are 1996 figures.
That is why I regard Kellogg as a buy-and-never-sell stock even though it is currently have trouble growing revenues. It belongs in that class of companies that has stable current profits, reliably returns a chunk of those profits as dividends, and avoids “reset” moments like Bank of America experienced during the financial crisis that can cause a company to spend years and years undoing a mistake. It is much easier to screw up poorly collateralized debt bundled together from borrowers with iffy job prospects than it is to screw up selling Pop-Tarts at grocery stores.
Furthermore, I do find it wise that Kellogg management is choosing to focus on making acquisitions within the snack sector rather than the cereal sector. The decision to buy Pringles from Procter & Gamble was wise, since that brand grows in the high single digits each year. It recently bought a 85% stake in Bisco Misr, an Egyptian biscuit company, which gives Kellogg an ownership interest in something that has double-digit growth, even though the company only generates $70 million in annual sales and is quite a few years away from moving the revenue needle in a way that will show up in profit reports.
The stock also comes with a slight lottery ticket component—there has been heavy speculation that 3G, the company that partnered with Warren Buffett to purchase Heinz—has an interest in taking over the company and doing its slash-costs-because-hey-its-not-our-family routine that has made them infamous and wealthy. For someone who owns Kellogg, there is that 5-15% chance of a quick 30% or so gain if the rumors prove true.
One of my favorite commenters over at Seeking Alpha likens a comprehensive stock portfolio to a wagon, with each of the stocks acting as horses carrying the wagon forward. Some are moving fast at a given time, others slower. As the years pass on, the rotation shifts and sometimes the slow ones pick up the pace while the fast movers slow down. Kellogg has been dealing with a few years of almost nonexistent revenue growth, and that is why Kellogg is not frequently touted as a buy candidate. That said, you get a 3.1% dividend in the form of a $0.49 quarterly payout that will rise with time, and Kellogg has yet to make a deep push into third-world markets and a move towards focusing on growth in the snack business will likely lead to faster growth sometime in the next few years. At the present time, though, Kellogg offers quality of profits without significant growth of profits, and it is likely true that: (1) you can find better blue-chip stocks to buy now, and (2) you will also be happy 15 years from now if you hold your existing Kellogg stock and reinvest the dividends along the way. Those statements are not mutually exclusive.
Originally posted 2015-02-15 18:36:16.