Kellogg Earnings: Looming Split Overshadows Solid First-Quarter Marks; Shares Attractive

Even as wide-moat Kellogg K chalked up solid first-quarter results (13.7% organic sales growth, 90 basis points of gross margin improvement to 31.3%, and a 50-basis-point uptick in adjusted operating margin to 13.5%), the market has its eyes on the impending split of Kellogg’s global snacking and North American cereal arms (slated to commence by yearend). It appears patience is wearing thin at the lack of disclosures (tentatively scheduled to hit the presses in late summer), evidenced by the 3% downdraft in shares on the print.

Similar to other consumer product manufacturers, though, Kellogg edged up its fiscal 2023 guidance (which presumes the two businesses operate under one roof for the entirety of the year). More concretely, Kellogg is now calling for 6%-7% organic sales growth (from 5%-7%) and a 1%-3% drop in adjusted EPS (from a 2%-4% decline prior, weighed down by higher interest expense and a pension remeasurement). A time value benefit would add $1-$2 to our $93 discounted cash flow model mark, but we continue to value the firm on a sum-of-the-parts basis; we place a 16 times EBITDA multiple on the global snacking unit and a 9 times EBITDA multiple on the North American cereal business, underpinning our unchanged $84 fair value estimate.

Shares strike us as undervalued, trading at a 15%-20% discount to our valuation while offering a 4% dividend yield. We’ve long held that the market hasn’t appreciated the strides Kellogg has taken to diversify beyond the mature cereal aisle into the more attractive snacks category (faster growth prospects and lower levels of private-label penetration) and emerging markets (where favorable income and demographic trends should manifest in long-term opportunities). Although we believe the rationale for the separation is rooted in a desire to unlock a higher multiple for the global snacks business (as opposed to management’s contention of unlocking more focus), we still think investors should consider indulging in shares.