WK Kellogg: Shares a Bargain as the Market Dogs Domestic Cereal Maker on Tepid Growth Prospects

We are initiating coverage of WK Kellogg KLGw 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.

Our no-moat rating is based on the firm’s singular portfolio exposure to a challenged category and its smaller scale as a standalone entity. When taken together, we think this position stands to damage its relationships with retailers that strive to stock up their shelves with key traffic drivers, while weakening its bargaining power when sourcing key ingredients, negotiating slotting fees, and securing advertising placements.

More critically, the firm’s aims to buoy its lackluster growth prospects through strategic tie-ups outside cereal in the medium to long term strikes us as perplexing, given this action runs counter to the stated benefits (enhanced focus on cereal) of the split with Kellogg’s global snacking business (now named Kellanova). We think such a move could prove value destructive if it extends the firm beyond its core competencies.