Kellogg Company
Analyst Report
December 2, 2011
Dave Fenz
KELLOGG COMPANY
Analyst Report
The Company
The Kellogg Company is one of the top companies worldwide in the manufacturing and
marketing of cereals and convenience foods. The company was founded in 1906 in Battle Creek,
Michigan, as a cereal company. It has since expanded its products into a variety of branded
cereals, ready to eat foods, and frozen foods. Its brands include Kellogg’s, Keebler, Cheez-It,
Murray, Austin, and Famous Amos. Kellogg sells and delivers an assortment of its 490 products
directly to grocery stores worldwide.
The Company maintains manufacturing operations in eighteen countries including Australia,
Brazil, Canada, China, Colombia, Ecuador, Germany, Great Britain, India, Japan, Mexico,
Russia, South Africa, South Korea, Spain, Thailand, and Venezuela. Kellogg’s products are sold
in 180 countries and approximately one-third of sales and one-fifth of profits come from abroad.
Kellogg’s is traded on the NYSE under the ticker symbol K at $48.98 (on 12/1/11).
Kellogg continues expanding its distribution channels and operations through innovation and
aligned acquisitions. It has a strong presence in developed countries of North America and
Western Europe; however, it faces more rigorous competition in less developed regions such as
Eastern Europe and Asia. That being said, the Kellogg’s brand name, along with the other brands
held by the company and its superior products create the sustainable competitive advantages of
perceived as well as actual product differentiation.
The Business
Kellogg has three categories of products that it offers: cereals, ready to eat foods, and frozen
foods. Offerings vary from region to region based on tastes and preferences.
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Cereals
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The company offers cereals that are targeted to a wide variety of consumer tastes and
preferences, from organic to healthy and sweetened cereals. Cereal products include
Cornflakes, Special K, Fruit Loops, Raisin Bran, Frosted Flakes, and Rice Krisipies.
Ready to Eat Foods
Kellogg has a wide variety of snack foods, cookies, crackers, and other ready to eat
foods. These offerings include various Keebler cookies and crackers, Pop-Tarts, Graham
Crackers, and Nutri-grain.
Frozen Foods
Frozen products include vegetarian Morningstar Farms dinners, imitation meats, Ego
frozen waffles, and Keebler Ice Cream Cones.
The main goals of Kellogg’s are to grow its cereals, expand snack offerings, and expand US
frozen offerings.
Competition
Kellogg’s main competitors are General Mills (GIS), Nestle (NSRGY.PK), and Ralcorp
Holdings Inc. (RAH). General Mills and Nestle are more diversified in their product offerings
whereas Ralcorp pursues a more similar strategy focusing in cereals and ready to eat foods but at
a smaller scale than Kellogg. General Mills and Nestle have been operating in Eastern Europe for
more than a decade together through a joint venture, which puts Kellogg behind in that region as
its most successful operations are in markets in more developed regions. Kellogg’s advantage
over its competitors is found in its more expansive list of branded cereals and snack foods.
Acquisitions
The company often uses aligned acquisitions to expand its offerings, markets, and distribution
channels. Its acquisitions are of companies who also manufacture and market cereals and ready
to eat foods. The acquisition of Keebler Foods Company in 2001 added leading snack brands and
also increased distribution channels. Other notable acquisitions include Worthington, a
vegetarian-based foods group, in 1999 and Kashi Company, an organic-based food group in
2000. Since these acquisitions, Kellogg’s stock price has been rising steadily. In 2001 the price
was between $25 and $30. Over the last ten years, the price has climbed around 100%.
Management
The management receives a fair level of income and is held to performance standards. Average
compensation for executives is $2.5M compared to a peer average of $4.17M, and 70%-87% of
their income is at risk based on their performance. In 2010 management failed to reach forecasts
and as a result did not get paid a bonus for that year. Also, executives are required to have shareownership between two and six times their annual base salary. This requirement aligns
executives and shareholders. The current Chairman of the Board, James M. Jenness, is a former
Kellogg Company | 12/2/2011
One acquisition that did not go as planned occurred in 2008. Kellogg’s acquired Navigable
Foods for approximately $36M in an attempt to reach northern and northeastern China. In 2010
the company recorded impairment charges of $29M. The Chinese business was operating at a
loss and was expected to continue doing so. Management commented that Navigable proved to
be the wrong vehicle for entry into the Chinese market. Nevertheless, Kellogg’s has a projected
ROI of 18% at a cost of capital of 8.8% through 2015.
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CEO of Kellogg, which allows the board to make decisions based on an understanding of how
the company operates.
The company is engaged in a share repurchase program, which is another sign of appropriate
management decisions that reflect shareholder interests. Over a three-year horizon ending in
December 2012, Kellogg’s plans to repurchase $2.5B in shares. It has currently repurchased
almost $1.7B, which is on pace with its repurchase program.
Financials & Profitability
Kellogg’s has healthy financials that are comparable to, or better than, industry averages and its
competitors. Its operating cash flows are enough to pay its interest back eight times. It has an
annual dividend rate of 1.72 and a dividend yield of 3.5%. Below are additional financial
figures.
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Kellogg maintains good profitability with a margin of 9.11% and an operating margin of
15.45%. It also has $1.20B in operating cash flow and a healthy levered free cash flow.
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Economic Moat
Kellogg’s economic moat comes from its branding and its superior products. Its branded
products are recognizable worldwide, its products are high quality, and it has a huge variety of
offerings within its product categories. In addition to these elements, the company also maintains
a diversified supplier base. These attributes grant the Kellogg Company pricing power.
Morningstar Perspectives
Bulls Say

With top-selling brands like Special K, Frosted Flakes, Corn Flakes, Rice Krispies, and Fruit Loops,
Kellogg is the leading domestic producer of breakfast cereals, with more than a 33% market share.

Strong brands, product innovation, and an impressive direct store delivery system have allowed Kellogg to
capture more than 5% of the estimated $60 billion domestic market for snack foods annually.

By using nearly 9% of sales to fund advertising and promotion, Kellogg appears well positioned to present
its value proposition to consumers in this fragile spending environment.

Kellogg is committed to enhancing shareholder return. The firm has raised its annual dividend 46 of the
past 50 years and targets an annual payout of 40%-50%. In addition, Kellogg has repurchased 1.5% of
outstanding shares on average annually over the past five years and intends to repurchase $1.5 billion over
the next two years.
Bears Say

Elevated commodity, packaging, and distribution costs, combined with increased marketing and
promotional spending, could hinder margin expansion at Kellogg over the near term.

Aggressive competition from retailers, private-label offerings, and other branded players is unlikely to
subside as consumer spending remains muted.

Given that more than 30% of its sales are derived from its international operations, Kellogg's results may be
hurt by unfavorable exchange rate movements.

Varying tastes and preferences in emerging markets are proving to be a high hurdle for Kellogg. The firm's
2008 acquisition of China-based Navigable Foods has plagued Kellogg for years, and management recently
acknowledged that this might not have been the best entry vehicle into this large and fast-growing region.
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Valuation
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I performed a conservative valuation using a beta of 0.6, PE target of 12, dividend and EPS
growth of 7%, book value growth of 8%, and I also lowered current EPS in accordance with
third quarter losses. The target price is an average of the three most closely clustered forecasts.
My valuation is based on a price of $49.80 (on the date of my presentation).The table below
compares other analysts’ projections to my forecast. Please note that Bloomberg and Yahoo
Finance both have a lower estimate. The reason is that their target prices are an average of
several months of analyst projections and may not reflect current figures.
Recommendation
I recommend that we sell 420 shares of Cabot Corp. (CBT) to raise funds as well as use $2,700
of our excess cash to purchase 319 shares of Kellogg (K) to bring Kellogg to approximately 5%
of our portfolio value. Kellogg Company has a solid foundation, is a great value stock, pays a
consistent dividend, and has an economic moat through superior products and brand recognition.
Sources
Bloomberg
Morningstar
Yahoo Finance
Kelloggcompany.com
Kellogg 10-K and 10-Q
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Value Line
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