Kellogg: A Stock To Reduce The Volatility Of Your Investment Portfolio (NYSE:K)

The US consumer goods manufacturer Kellogg Company (NYSE:K) was founded in 1906 and currently has 31,000 employees. The company is engaged in both the manufacturing and marketing of snacks and convenience foods. The brands sold by the consumer goods manufacturer include Pringles, Kellogg’s and Cheez-It, to name just a few. I have presented my investment thesis as follows:

Investment Thesis

• Kellogg‘s high dividend yield (3.43%) in combination with its low dividend payout ratio (55.40%) and its beta of 0.57, make the company an attractive stock for investors aiming to reduce the volatility of their investment portfolio.
• These characteristics also make the stock appealing for dividend-income investors who are primarily looking for income rather than capital gains.
• In my opinion, however, Kellogg is currently not valued low enough to rate the company as a buy. Due to Kellogg‘s current valuation and the low growth perspectives of the company, I rate them as a hold.

Industry Overview

Kellogg is a company from the non-cyclical consumer goods industry. This industry is characterized by the fact that companies are able to generate relatively stable revenue and profits over time. Products from the consumer goods industry are consistently in demand even during economically difficult times. Another characteristic of this industry is the strong competition and relatively limited growth prospects for most companies from the sector. The Economist Intelligence Unit expects growth in retail volumes worldwide to slow to 3.3% in 2022.

However, investors who are long-term oriented and who primarily focus on dividend income, as well as investors who are looking for attractive investments to reduce the volatility of their investment portfolio, can find attractive companies in this industry. One of which is the Kellogg Company, which I will analyze in more detail in this article.

Business Model of Kellogg

The products of Kellogg are manufactured in 21 countries and their products are marketed in more than 180 countries across the world. Kellogg‘s products are sold to retailers via direct sales in order to be resold to consumers.

Kellogg distinguishes among the following business units: snacks, cereals, frozen as well as noodles and other. In the business unit of snacks, Kellogg generated a revenue of $6.807 billion in 2021. This is 48% of its total revenue in 2021 and makes snacks the most important business unit in terms of revenue. In the business unit cereal, Kellogg generated a revenue of $5.123 billion, which at 36% of their total revenue is the second most important business unit. The business unit of frozen (8% of the total revenue) as well as the business unit noodles and other (also 8% of the total revenue) account for a smaller proportion of Kellogg‘s total revenue.

The revenue of the business unit snacks increased from $6.281 billion in 2020 to $6.807 billion in 2021. This corresponds to a rise of 8.4%. In contrast, revenue of the business unit cereals decreased from $5.433 billion in 2020 to $5.123 billion in 2021, corresponding to a decline of 5.7%. The frozen business unit shows a decrease of 2.9% and the noodles and other business unit increased by 24.8%.

The fact that Kellogg’s second most important business unit of cereals suffered a revenue decrease in 2021 in comparison to 2020, reflects the growth challenges they are facing and furthermore reflects characteristics of the low growing business environment, in which the company is operating.

Company Results in Fiscal Year 2021

Kellogg‘s consolidated net sales increased from $13.770 billion in 2020 to $14.181 billion in 2021. This is a rise of about 3%. In the same period, Kellogg‘s EBIT decreased from $1,782 billion to $1,680 billion, resulting in a decrease of 5.7%. The decline in Kellogg‘s EBIT in 2021 in comparison to 2020, can be interpreted as another indicator of their current growth difficulties.

Kellogg‘s average revenue growth of the past five years has been 1.4% per year. This low revenue growth is further evidence that Kellogg operates in a challenging business segment.

For a more detailed analysis, I will look at the results from each of the geographic markets in which Kellogg operates. The company differentiates between North America, Europe, Latin America and AMEA (Asia Pacific, Middle East and Africa).

In North America, net sales decreased from $8,361 billion in 2020 to $8,174 billion in 2021. This is a decline of 2.2%. In Europe, net sales increased from $2,232 billion in 2020 to $2,397 billion in 2021, resulting in a rise of 7.4%. In Latin America net sales went up from $914 billion in 2020 to $997 billion in 2021, which means a growth in net sales of 9.1%. In AMEA, net sales saw an increase from $2,263 billion in 2020 to $2,613 billion in 2021, resulting in a gain of 15.5%.

With a 57.6% share of total revenue, North America is the most important market for Kellogg, followed by AMEA (18.4%), Europe (17%) and Latin America (7%). The fact that North America revenue decreased in 2021 compared to 2020, is a further indicator of the difficulties Kellogg face in expanding their business.

Kellogg‘s Competitive Advantages

Due to the high and relatively stable earnings that Kellogg generates year over year, the company is able to spend a substantial proportion of its earnings on the research and development of new products as well as in the marketing of its existing products. In 2021, Kellogg spent $134 million on research and development and $790 million on advertising. Those spendings make it more difficult for potential competitors to enter into the already highly competitive consumer goods market.

Furthermore, Kellogg has managed to build brands and to create a product distribution network during its more than 100 years of history as a company. Furthermore, they have been able to build economies of scale that help the company to stand out against their competitors. With Pringles, Kellogg owns a strong consumer brand that the company acquired from Procter & Gamble (PG) back in 2012. With the brands Kellogg’s and Cheez-It, the company has a number of important brands in its product portfolio that consumers have been familiar with for decades.

The fact that Kellogg has already existed for more than 100 years, shows us that the company has been able to adapt to different consumer preferences over time. Therefore, I expect the company to respond successfully to changes in consumer preferences in the future.

I believe that the competitive advantages listed above will ensure that Kellogg will continue to be able to generate stable profits in the future. Due to the company‘s proven ability to generate high profits even in economically challenging times, I assume that Kellogg’s stock will continue to be less volatile than the broader stock market. For this reason, I assume, that you will be able to reduce the volatility of your investment portfolio by investing in Kellogg.

Growth Opportunities

It has previously been shown that Kellogg recorded its largest revenue increase in the AMEA region, with a rise in net sales of 15.5%, followed by Latin America with a growth of 9% in 2021 compared to 2020.

Due to the fact that populations are growing faster in countries of the AMEA region as well as in Latin America, compared to North America and Europe, I expect that these regions will continue to offer Kellogg’s the highest growth prospects in the future.

In my view, the cereals business unit will continue to offer very limited growth opportunities. This is due to the fact that people usually only have breakfast once a day. Only in the AMEA and Latin America region I do see some growth potential for this business unit due to the growing population as well as the growing middle class of its countries. I assume that the business unit of snacks will continue to offer higher growth prospects in comparison to the cereals business unit.

Due to the fact that Kellogg has only grown its revenue by 1.4% on average per year in the last 5 years and the ongoing limited growth opportunities, I expect that they will continue to grow at low growth rates in the future.

However, although growing at low growth rates, I believe that Kellogg’s high and relatively stable profits continue to contribute to the fact that the company‘s stock will be less volatile than that of the broader stock market.

Valuation

In terms of valuation, I have used the EPS Multiplier Method to determine the intrinsic value of Kellogg. The method calculates a fair value of $50.25 for the company. At the current share price, this results in a downside of 26.6%.

In the next sections, I will explain the assumptions of my calculation:

The Seeking Alpha EPS Diluted Growth (FWD) rate of Kellogg is 2.5%. Therefore, I assume an EPS growth rate of 3% for the company over the next 20 years. I have used Kellogg‘s current discount rate (WACC) of 4.85% to calculate a fair value.

My calculations are based on the following information as presented below:

Company Ticker	K
EPS	$4.36
Discount Rate	4.85%
Growth Rate for the Next 20 Years	3%
Current Stock Price	$68.42
PE Ratio	15.69

Based on the above assumption, I calculated the following results:

Intrinsic Value	$50.25
Current Stock Price	$68.42
Margin of Safety	-36.20%
Upside/Downside	-26.60%

Source: The Author

Relative Valuation Models

Kellog‘s P/E (FWD) Ratio

Kellogg‘s P/E Ratio is currently 16.61 while their average P/E Ratio of the last 5 years is 17.02. The comparison shows us that the current P/E Ratio of Kellogg‘s is 2.42% lower than its average P/E Ratio from the last five years. This indicator suggests that the company is currently slightly undervalued.

When comparing Kellogg‘s P/E Ratio of 16.61 with the sector medium of 20.58, it provides us with another indicator suggesting that Kellogg is currently undervalued. The current P/E Ratio is 19.29% below the sector medium.

Kellogg in comparison to some of its competitors

	Kellogg	PepsiCo	Kraft-Heinz	Nestle	Danone
Market Cap	22.95B	235.73B	51.64B	352.71B	36.23B
Revenue	14.18B	79.47B	26.04B	95.88B	27.64B
Revenue Growth 5 Year (CAGR)	1.81%	4.82%	-0.20%	-0.52%	2.04%
EBIT Margin	14.26%	14.85%	21.01%	17.04%	13.74%
P/E GAAP (FWD)	16.61	25.39	16.28	26.96	16.92
Dividend Yield (FWD)	3.40%	2.49%	3.75%	2.37%	4.11%
Dividend Payout Ratio	55.40%	67.96%	54.42%	45.38%	65.99%
Dividend Growth 5 Yr (CAGR)	2.41%	7.39%	-11.52%	5.91%	21.13%
Consecutive Years of Dividend Growth	17 Years	49 Years	0 Years	5 Years	0 Years

Source: Seeking Alpha and Morningstar

In the table above we can see that PepsiCo (PEP) has managed to grow at a higher revenue growth rate than Kellogg in the last five years. As a result, PepsiCo has managed to further increase its dividend at a higher rate than Kellogg was able to. In my opinion, the higher growth rates of PepsiCo in combination with their brand strength justifies the higher P/E Ratio of PepsiCo (26.25) in comparison to Kellogg (16.51).

Kellogg‘s has a relatively low dividend growth rate of 2.41% annually over the last 5 years. Given that Kellogg operates in a relatively saturated consumer goods market and taking into consideration the future low profit growth prospects of the company, I believe Kellogg investors will continue to see only modest compound annual dividend growth in the years to come.

In my view, however, the relatively low dividend payout ratio of Kellogg (55.40%) suggests that there should be no dividend cuts, at least in the short to medium-term, and that the dividend can be increased at least to a very small extent in the coming years. The fact that Kellogg has been able to increase the dividend year after year for the past 17 years, strengthens my belief that the company can continue to do so, though in continuously low growth rates.

Kellog‘s Beta

The stock of Kellogg has a beta of 0.57, which is below that of the broader stock markets (a beta of 1). This is yet another indicator that an investment in the company can contribute to a reduction of volatility in your investment portfolio.

Risks

I see the strong and intense competition in the consumer goods industry as one of the main risks for Kellogg. The company has strong competition from competitors like PepsiCo, who are growing faster than Kellogg.

At the same time, competitors such as PepsiCo, Nestle (OTCPK:NSRGY) and Danone (OTCQX:DANOY) have been able to establish even stronger brand images than Kellogg. For example, PepsiCo is ranked at 36 on the Forbes list of the most valuable brands in the world. Furthermore, PepsiCo even has some sub brands that are ranked on the list such as Frito Lay. Nestle is ranked at position 54 and Danone at 82. Kellogg, however, does not appear in the ranking of the 100 most valuable brands in the world.

In times of high inflation like now, companies with the strongest brand images are the most likely to be able to pass on to consumers the increased costs they have in the manufacturing process of their products. That’s why I think that a company like Kellogg, which doesn’t have such a strong brand image in comparison to some of its competitors, could be more likely to suffer from high inflation. Thus, they might not be able to pass the higher prices on to consumers to the extent that PepsiCo can, potentially resulting in lower profitability for the company in the future.

Another risk for Kellogg that I see, is consumers shifting to even more generic and lower priced products than them. Especially in difficult economic times, consumers might prefer to buy no-name brands that are cheaper than products from Kellogg. This could furthermore cause a decrease in Kellogg‘s revenue and reduce the company‘s operating margins.

The Bottom Line

The EPS Multiplier Method, which I have used to calculate the intrinsic value of Kellogg, calculates a fair value of $50.25 for the company. At the current share price, this results in a downside of 26.6%. Based on this calculation, the stock of Kellogg can currently be considered as overvalued.

Personally, I don’t own any stocks of Kellogg and rate the stock as a hold at its current price. I don’t see the stocks of Kellogg as a buy given the company’s minor growth prospects and the lower strength of its brand image compared to other manufacturers of consumer goods, such as PepsiCo. Especially in times of higher inflation like the current one, as an investor I would look more toward companies with higher growth prospects that have managed to build an even stronger brand image than Kellogg. I assume that companies with an even stronger brand image will be more likely to be able to pass on the higher prices caused by inflation to consumers.

In my view, however, the Kellogg stock may appeal to the type of investor who wants to stabilize their investment portfolio and expand their portfolio with less volatile stocks. In this case, the investment in Kellogg could be attractive because of their relatively high dividend yield of 3.43%, as well as the relatively low payout ratio of 55.40% (which makes a dividend cut less likely in the near future) and its low beta of 0.57 (which is an indicator of Kellogg‘s low stock volatility). In my opinion, these characteristics also make the Kellogg stock appealing for dividend-income investors, who are primarily seeking income instead of capital gains.