Morningstar | Kellogg Ups the Ante on Brand Spend in an Effort to Drive Profitable and Sustainable Top-Line Gains
After just more than a year at the helm, Kellogg CEO Steve Cahillane has laid out his strategic roadmap after closing the chapter on its move away from direct-store distribution. We’ve long viewed this shift (toward warehouse distribution, which was initially disclosed in February 2017) as a prudent means 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 expend around 7% of sales, or about $1 billion annually, to R&D and marketing, which should ensure Kellogg is able to weather competitive pressures--resulting from other branded operators, small niche peers, and lower-price private-label fare.Beyond efforts to grow the top line by extending the distribution of its mix and reinvesting in product innovation (including new pack formats) aligned with consumer trends, we also surmise further investments in its manufacturing platform will also be in the cards over the near term. For one, on-the-go pack sizes have been boasting outsize demand at Kellogg of late, but given the firm did not have the supply chain capabilities to meet this heightened demand, this growth has weighed on profits. However, we believe these investments stand 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 disclosed that it is exploring 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 consolidated base. However, we don't believe the firm opted for this course due to poor performance, as Keebler Fudge Shoppe, Mother’s, and Famous Amos chalked up 2%, 2%, and 5% growth in 2018 in retail sales on its home turf. At 2 times sales (just less than the 3 times sales expended for recent transactions in the space based on data from PitchBook and company filings), we think these funds could be used to finance organic and inorganic investments in the business, which we view as prudent.Kellogg is engaged in the manufacture and marketing of ready-to-eat cereal and convenience foods. The company's principal products are snacks, such as crackers, savory snacks, toaster pastries, cereal bars, granola bars and bites; and convenience foods, such as, ready-to-eat cereals, frozen waffles, veggie foods and noodles. The company's snacks brands are marketed under brands such as Kellogg's, Cheez-It, Pringles, Austin, Parati, and RXBAR. The company's cereals and cereal bars are generally marketed under the Kellogg's name, with some under the Kashi and Bear Naked brands. The company's frozen foods are marketed under the Eggo and Morningstar Farms brands.
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