EUR 850.00 For Business Accounts Only

Morningstar | Kellogg Slims Down by Selling Cookie Assets to Ferrero; Shares Worth Snacking On

Wide-moat Kellogg announced on April 1 it has inked an agreement to sell its cookie, fruit snack, cone, and pie crust businesses (including brands such as Keebler, Mother’s, Famous Amos, and Stretch Island) to privately held Ferrero for $1.3 billion. The deal, which is expected to close by the end of July, implies a valuation of around 1.5 times trailing sales (only modestly below the 2 times expectation we had previously laid out) and 17 times operating income, which still strikes us as a decent price. Kellogg initially disclosed its intention to part ways with these assets in November, given its belief that it was unable to sufficiently invest to support the growth of these offerings (as brands such as Pringles, Cheez-It, and Pop-Tarts among others have been a higher priority for R&D and marketing dollars). As such, we don’t believe this sale was prompted by poor performance, which aligns with the fact that Keebler Fudge Shoppe, Mother’s, and Famous Amos boasted 2%, 2%, and 5% growth in 2018 in retail sales on its home turf.

Management has signaled its intent to direct the proceeds from the sale toward the reduction of debt, which we view as prudent as debt/adjusted EBITDA stood at 3.7 at the end of fiscal 2018 (above its prior five-year average of 3.1). We continue to view the firm’s stewardship of shareholder capital as Standard and expect that the combination of debt-paydown, returning excess cash to shareholders, and investing in organic and inorganic growth opportunities will remain the crux of its capital allocation priorities.

Overall, we don’t intend to alter our long-term forecast (2%-3% average annual sales growth through fiscal 2027 and 400 basis points of operating margin expansion to around the high-teens by the end of the decade) and see little change to our $78 fair value estimate. Shares trade at around a 25% discount to our valuation and when combined with its 4% annual dividend yield, we think Kellogg’s shares offer a compelling bargain.

From our vantage point, this announcement provides credence to our take that despite its aims to elevate the trajectory of its top-line performance (by extending the distribution of its mix and reinvesting in product innovation, including new pack formats, aligned with consumer trends both at home and abroad), management is reluctant to do so at any cost. We believe Kellogg's current course is a byproduct of its decision more than two years ago to shutter its direct-store distribution model in favor of warehouse distribution. We posit this shift positions Kellogg to remove complexity from its business while freeing up funds to reinvest in brand-building instead of its distribution network. We continue to anticipate the firm will direct around 8% of sales, or about $1.2 billion annually, toward research, development, and marketing over the next 10 years, which should aid in its efforts to withstand competitive pressures from other branded operators, small niche peers (which have proved more agile in responding to evolving consumer trends), and private-label fare.