Buy, Sell or Hold: What's So "Special" About Kellogg?

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Everybody knows Kellogg Company (NYSE: K) by its superb line of breakfast cereals.

What they don't know is that thanks to the purchase of Pringles from Procter & Gamble (NYSE: PG) , Kellogg has become second in the snacks business behind PepsiCo (NYSE: PEP).

In fact, since Kellogg completed the $2.7 billion Pringle acquisition on June 1, 2012 the company's share price has increased over 30% with nary a pause.

Now I realize that eating just one Pringles potato chip is impossible, but does that justify the market's appetite for Kellogg's shares?

Here's my breakdown on the stock...

International Sales to Get a Pringles Pop

In my travels around the world I've run into all types of cuisines. Sometimes they don't always quite agree with my delicate stomach. But w ith Pringles sold in 150 countries, I've always found comfort in knowing that no matter where I went there was always a Pringles pop box nearby.

That type of presence will benefit Kellogg by using those same Pringles distribution channels to introduce its line of other Kellogg's brands into those markets. Prior to the May, 2012 Pringles acquisition, 32% of Kellogg's net sales came from outside of North America. To really get an idea of how well the company is integrating its Pringles operation we'll need to look to Q3/2013 and Q4/2013 comparable figures.

But Kellogg's focus on international growth doesn't just end with the Pringles synergies. They have also formed a shrewd joint venture with one of China's largest consumer goods players - Wilmar International. Together they hope to capitalize on Kellogg's strong brand awareness and Wilmar's manufacturing and distribution abilities to boost sales to the millions of China's nouveau riche middle-class.

Needless to say, that would work to open up a huge new market.

In fact, Kellogg's President and CEO, John Bryant recently stated "China's snack-food market alone is expected to reach an estimated $12 billion by year-end (2012), up 44% from 2008."

Road Ahead May Not Be "Grrrreat!"

The problem is, even if Kellogg's plans for future growth were to bear some fruit in the long-term, there are a few obstacles ahead that may make an investor's cereal a little soggy.

Growth has been slow going across the board. In North America, organic sales (not including Pringles) from the most recently reported quarter grew 5.5% from the prior-year quarter. Europe's quarterly increase was 2.7%, Asia Pacific's 4.6% and Latin America's a surprising 9.4%.

Admittedly, when attempting to figure overall operating profit, the picture gets a little convoluted since the acquisition of Pringles (as well as a plant closure in Australia) skews the numbers a bit.

Suffice it to say profits weren't stellar and management sees plenty of room for improvement as CEO John Bryant said, "We are essentially a turnaround that is turning ... and heading in the right direction."

What's more, rising food inflationand increased commodity prices are major concerns for food manufacturers like Kellogg, since consumers are highly concerned about getting a good deal on their food purchases.

Some of Kellogg's cereal competitors have been lowering prices to increase market share. This will obviously weigh on Kellogg's margins if they decide to follow suit to find proper price points for its cereal brands. Again, John Bryant stated that, "Our gross margin is down a little bit year-on-year but that's largely due to Pringles integration and we'd love to see that gross margin set to track in the right direction, improving over time." Time will tell.

Kellogg has had its share of media problems as well. In the rush to cut costs during the economic downturn, the company might have shortchanged some of its quality controls.
Earlier this year, Kellogg, was forced to recall Special K Red Berries cereal when glass fragments were discovered.

Unfortunately, this is not a one-time issue for Kellogg. In 2011, the company had to recall Mini-Wheats cereal when metal mesh was found in the boxes. In 2010, a group of cereals were recalled for emitting strange odors. And in 2009, some Keebler and Famous Amos cookies were recalled due to possible Salmonella.

That calls into question whether or not Kellogg's quality controls are up to snuff. The company does reassure that they have made it a priority, but nevertheless the issues keep cropping up.

Let Go Your Eggo?

On a fundamental basis, Kellogg had a strong cash flow of $1.2 billion for fiscal-year 2012. With that kind of cash flow the company has been able to increase dividends for the last 8 years. In this case, dividend seeking investors will be very happy with a company that today pays 44 cents per quarter and yields 2.8% annually, which is 59% better than the 1.76% you get from 10-year U.S. Treasuries.

However, with the acquisition of Pringles, Kellogg assumed a lot of debt.

Currently total debt is approximately a hefty $9 billion, of which $7 billion is long-term debt for a company with a $23 billion market cap. Kellogg, however, has taken advantage of the currently low-interest rate environment and has refinanced many of its high-interest burdens.

Kellogg's share price has done extremely well since the acquisition of Pringles. The chart below shows the one-track upward move as it continually makes all-time highs.

Source: Yahoo Finance

So here's the bottom line:

Although the company still has room for growth, I don't believe the stock chart does.

My guess is that much of the promising Pringles story has now filtered into the stock price. At some point the price will have to take a breath and digest that huge 30% move it made in such a short period of time.

If that were to happen, I may consider a purchase, but in the meantime if I were currently a shareholder I would HOLD and have a stop price that would lock-in some of the nice gains I've enjoyed.

[Editor's Note: If you have a stock you would like to see us analyze in a future issue, leave us a note in the comments below and we'll add it to our list.]

About the Author:David Mamos brings nearly 15 years of analytical experience to the table with a background ranging from big-picture fundamental analysis to highly technical trading decisions. He began his career working as a financial advisor with Royal Alliance in 2001 and helped clients with portfolio management as well as buy-sell decisions before transitioning to the development, implementation and execution of trading strategies for aggressive investors.

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