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Morningstar | Despite Slimming Down, Wide-Moat Kellogg Prudently Working to Cook Up Profitable Sales Growth

After just more than a year at the helm, Kellogg CEO Steve Cahillane has laid out his strategic road map after closing the chapter on its move away from direct-store distribution. We’ve long viewed this shift toward warehouse distribution, initially disclosed in February 2017, as a prudent way to extract complexity from its operations while freeing up funds to reinvest in brand-building as opposed to its distribution network prior. We forecast Kellogg will spend around 8% of sales, or about $1.2 billion annually, on R&D and marketing, which should ensure it weathers competitive pressures--resulting from other branded operators, small niche peers, and lower-price private-label fare.Beyond efforts to grow sales by extending the distribution of its mix and reinvesting in product innovation (including new pack formats) aligned with consumer trends, we also expect further investments in its manufacturing platform over the near term. For one, on-the-go pack sizes have been boasting outsize demand at Kellogg lately, but because the firm did not have the supply chain capabilities to meet this heightened demand, this growth has weighed on profits. However, we believe this spending stands to support the intangible assets that underpin its wide moat over a longer horizon.However, we don’t think the firm is anchored on growing for the sake of it. In this vein, management recently announced the sale of its cookies, fruit snacks, cones, and pie crust businesses (including brands such as Keebler, Mother’s, Famous Amos, and Stretch Island), which make up around $900 million in annual sales or about 7% of its total base, to Ferrero for $1.3 billion. We don't think this decision was driven by poor performance, as Keebler Fudge Shoppe, Mother’s, and Famous Amos chalked up 2%, 2%, and 5% growth, respectively, in 2018 in retail sales on its home turf. Rather, we think this allows Kellogg to increase support for its core offerings (including Pringles, Cheez-It, and Pop-Tarts among others). Further, we view its intent to use the proceeds to reduce debt as prudent given debt/adjusted EBITDA stood at 3.7 as of fiscal 2018 (above its prior five-year average of 3.1).