Company Reports

Even with the intended benefits enhanced focus should unlock, we fail to see an enduring competitive advantage in WK Kellogg as a stand-alone business. For one, we surmise its leading market share position in the North American cereal aisle is diluted as its entire portfolio sits in a shrinking category. In our view, this dents its relationships with retailers that strive to stock shelves with key traffic drivers. Further, without ties to the faster-growing snacks arm (which now sits inside narrow-moat Kellanova), WK Kellogg is left with subpar scale (generating less than $3 billion in sales annually), which likely weakens its bargaining power when sourcing key ingredients, negotiating slotting fees, and securing advertising placements.

Since its last earnings report in mid-February, shares of no-moat WK Kellogg have climbed nearly 70% as investors have increasingly bought into the merits of the firm's strategic agenda, which is anchored in lifting profits through supply chain modernization initiatives. Such efforts continued in the first quarter, surfacing through 130 basis points of adjusted EBITDA margin expansion to 10.6% on stepped-up productivity gains. This improvement bolsters our confidence in the firm's ability to buoy margins by 500 basis points over the next few years as it unlocks further efficiencies. We intend to maintain our long-term outlook for the business (flat average sales growth and mid-teens EBITDA margins) and our $27 per share fair value estimate (outside of a modest bump for time value).

Despite the intended benefits more focus should unlock, we fail to see an enduring competitive advantage in WK Kellogg as a stand-alone business. For one, we surmise its leading market share position in the North American cereal aisle is diluted as its entire portfolio sits in a shrinking category. In our view, this dents its relationships with retailers that strive to stock shelves with key traffic drivers. Further, without ties to the faster-growing snacks arm (which now sits inside narrow-moat Kellanova), WK Kellogg is left with subpar scale (generating less than $3 billion in annual sales), which likely weakens its bargaining power when sourcing key ingredients, negotiating slotting fees, and securing advertising placements.

Investors cheered no-moat WK Kellogg’s fiscal 2023 fourth-quarter results (shares jumped nearly 10%) as it eked out solid margin gains—standalone adjusted gross and EBITDA margins inflated 300 and 270 basis points to 29.2% and 8.2%, respectively. In our view, these results illustrate the firm’s stringent focus on extracting inefficiencies. Given this focus, we see a viable path to midteens EBITDA margins by fiscal 2026 as it further modernizes its supply chain and optimizes its network.

Despite the intended benefits more focus should unlock, we fail to see an enduring competitive advantage in WK Kellogg as a stand-alone business. For one, we surmise its leading market share position in the North American cereal aisle is diluted as its entire portfolio sits in a shrinking category. In our view, this dents its relationships with retailers that strive to stock their shelves with key traffic drivers. Further, without ties to the faster-growing snacks arm (which now sits inside narrow-moat Kellanova), WK Kellogg is left with a subpar scale (generating under $3 billion in annual sales), which likely weakens its bargaining power when sourcing key ingredients, negotiating slotting fees, and securing advertising placements.

We don’t plan a material change to our $26.50 fair value estimate after digesting WK Kellogg’s solid third-quarter marks. During the quarter, standalone gross and EBITDA margins swelled 290 and 310 basis points to 28.5% and 7.5%, respectively, despite a 1.9% drop in net sales, thanks to revenue growth, management efforts, and improved productivity. Still, we view shares as deeply undervalued. Current market pricing suggests just 8% EBITDA margins by 2032, by our calculations, which doesn’t seem to incorporate much margin upside from supply chain modernization and network optimization initiatives. However, we believe such efforts will enhance operational efficiencies and structurally lift profits, with the firm calling out 20% efficiency and 50% cost gaps between its lowest- and highest-cost plants. As such, we maintain our long-term forecasts for flat average top-line growth and 14% EBITDA margins, near the firm’s midteens target.

We are initiating coverage of WK Kellogg with a $26.50 fair value estimate and no-moat designation. We view shares as deeply undervalued, trading nearly 45% below our intrinsic valuation. We posit the market is penalizing the standalone firm’s tempered growth prospects—with a portfolio now entirely tied to the competitively challenged U.S. cereal category—while failing to appreciate the margin opportunity that should be unlocked by its supply chain modernization initiative. Indeed, we anticipate WK Kellogg will continue to face intense competition from numerous breakfast alternatives, with our top-line forecast calling for a low-single-digit decline to flat sales marks over our 10-year explicit forecast period (even as it invests around 11% of sales in research, development, and marketing). Nonetheless, we believe realigning its manufacturing footprint and facilities network and investing in technology and automation will afford profitability gains, with our midcycle operating EBITDA margin approaching 14%, up from the 9% we forecast for fiscal 2023, in line with management’s midteens target by fiscal 2026.

Despite the intended benefits more focus should unlock, we fail to see an enduring competitive advantage in WK Kellogg as a standalone business. For one, we surmise its leading market share position in the North American cereal aisle is diluted as its entire portfolio sits in a shrinking category. In our view, this dents its relationships with retailers that strive to stock their shelves with key traffic drivers. Further, without ties to the faster-growing snacks arm (which now sits inside Kellanova), WK Kellogg is left with a subpar scale (generating under $3 billion in annual sales), which likely weakens its bargaining power when sourcing key ingredients, negotiating slotting fees, and securing advertising placements.