Kellogg Company (K), a firm best known for their strong cereal brands, delivered a quarter that was a treat for their investors. First quarter profit leaped 30% to $418 million or $1.09 per share, much better than the 94 cents per share analysts expected. Earnings were boosted by sales that grew 5% to $3.32 billion, also better than the 3.8% growth Wall Street was expecting. Revenue in North America rose 3% and international sales gained 9% on a year ago (7% due to favorable exchange rates). Despite strong competition for grocery shopper’s dollars from store brands et al, Kellogg resisted the urge to lower prices and K actually rose by .9% in the US and 1.3% globally. This reflects well on the company’s pricing power and core brand strength. The stock closed on Thursday 4.6% higher on the back of these results.
Sales growth, while better than expected, was only a small part of the overall better performance as Kellogg effectively reduced costs through lower advertising expenses and higher productivity. Kellogg management
continues to work towards the long term goal of $1 billion in cost savings initiated last year. Cost cutting and strong sales helped to boost gross margin by 190 basis points to 43%.
In addition to the quarterly report, Kellogg also announced an impressive $2.5 billion share buyback authorization over the next 3-years. As we often note in such a circumstance, the company is not really required to devote any amount of resources to buy back shares, but if it feels it is in the best interest of shareholders (because the stock is too cheap) Kellogg has the ability to support their stock. At a current market cap of less than $21B, they could potentially buy about 12% of outstanding shares at today’s prices.
For the year ahead, management stood by their previous guidance of earnings growth in the range of 11% to 13%, excluding the impact of currency fluctuations. This implies earnings per share of $3.51 to $3.57, which is actually slightly lower than the consensus analyst’s estimates of $3.59. The full year sales growth guidance of 2% to 3% is also a little bit more conservative than the analyst’s projections.
At Ockham, we continue to believe Kellogg is Undervalued based on the current fundamentals. When we compare current fundamentals to historically normal valuations, we believe the current price is still quite reasonable. For example, over the last ten years the market has been willing to pay between 17.1x and 22.5x cash earnings per share, but the current price-to-cash earnings is only 16.8x. The current price-to-sales of 1.65x is on the low end of the historically normal range of 1.56x to 2.04x. These metrics and other elements of our analysis suggest to us that there is still compelling value for long term investors. The company continues to thrive despite a challenging sales environment through effective management, and Kellogg should benefit with continued steady economic improvements.
