We Think Kellogg’s Planned Split Will Destroy Value, But Shares Are Attractive

We’ve long held that the market has failed to appreciate the strides that wide-moat Kellogg (K) has made to diversify into on-trend snacking and faster-growing emerging markets, rendering the shares undervalued. While we’d thought continued investments in product innovation and packaging across its portfolio would prove a tasty recipe for profitable top-line growth over a longer horizon, management has opted to pursue another course: It intends to split its global snacking arm (with around $11.4 billion in annual sales and low-teens operating margins) from its North American cereal ($2.4 billion in annual sales and high-single-digit operating margins) and plant-based alternative segments ($340 million in annual sales and low-double-digit operating margins). The two spinoffs are expected to be completed by the end of calendar 2023.

Despite the increased focus that management claims this should afford, we don’t think this strategic action stands to enhance Kellogg’s competitive position or financial prospects. In our opinion, the motivation leans more toward unlocking a higher multiple for the faster-growing snack business once it’s unencumbered by the more mature North American cereal brands. Based on a sum-of-the-parts analysis, we assume the global snack business could garner an EBITDA multiple of 16 times, while the North American cereal business could see an EBITDA multiple of 9 times (due to its slower growth but potential for margin expansion) and the plant-based business amasses a 20 times EBITDA multiple (given the attractive growth prospects that categorize the space); this generally aligns with prior industry transactions. As a result of the pending split and the dissynergies we expect from reduced scale and added back-office functions, we expect to lower our Kellogg fair value estimate to $83 per share from our current discounted cash flow intrinsic valuation of $88. However, we’re holding the line on our Standard capital allocation rating.