Kellogg Sales Improve, Shares a Bargain

While peers have recently been boasting modest improvements in top-line performance, Kellogg (K) has been a laggard with flat to slightly negative sales over each of the prior three quarters. However, we've been of the opinion that strategic actions taken during the past few years, including the move away from direct-store distribution in favor of warehouse delivery, divestments of noncore offerings and stock-keeping units, and enhanced investments behind its manufacturing capabilities and brands, have laid the foundation to reignite sales. Kellogg has finally evidenced the merits of its recent course in the second quarter, with organic sales growth of more than 2%, which we view as more impressive as gains extended across each of its geographic regions, with North America, Europe, Latin America, and Asia up 1.1%, 1.8%, 2.3%, and 8.5%, respectively. Even though the firm was lapping more muted performance in the year-ago period (down 0.4%), we think it's poised to chalk up low-single-digit sales even in the face of the intense competition. (Other branded operators and small niche peers have proved more agile in responding to evolving consumer trends.) Kellogg's lower-price private-label offerings and added spend also support the brand intangible asset that underlies its wide moat.

The market also found favor with Kellogg’s results, as shares popped around 10%. However, the firm's six-month results and fiscal 2019 guidance remain aligned with our full-year outlook of a nearly 2% decline in sales and operating margins of almost 14%. We don’t anticipate making any changes to our $78 fair value estimate or our long-term forecast calling for 2%-3% average annual sales growth and around 400 basis points of operating margin expansion relative to the average over the past three years to more than 18% by fiscal 2028. Despite the recent rally, we still view the shares as attractive, especially when considering Kellogg still offers a 4% dividend yield.