Invest in Breakfast for Healthy Returns

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Some say breakfast is the most important meal of the day.

Companies that rely heavily on breakfast foods for revenue and earnings would likely agree. Especially since breakfast eaten at home is "thriving, representing over 80% of all breakfast occasions last year," according to Don Mulligan, CFO of General Mills (NYSE: GIS).

So how to invest in the lucrative breakfast business?

The General and cereal...

Cereal is one of the most recognizable breakfast foods in the United States. It is also a market that may have a good amount of room to expand internationally. According to Mulligan:

"We believe the global cereal category is poised for strong future growth. That’s because more than half of today’s cereal consumption happens in just four countries – the US and Canada, and the UK and Australia. But these markets represent only 6% of the world’s population. For the remaining 94% of consumers, cereal eating occasions per capita are still quite low so we see great opportunity ahead for our cereal business."

Cereal is by far General Mills' main strength and is the most popular eaten-at-home breakfast domestically by far. The company's brand portfolio of cereals includes: Cheerios, Cinnamon Toast Crunch, Chex, and Lucky Charms-- just to name a few-- and these brands account for over 20% of cereal category sales. And the cereal isn't just for kids-- as Mulligan surprisingly revealed that adults accounted for over half of Lucky Charms consumption.

While breakfast eaten at home is lucrative, it has also been on the decline among adults, according to Bloomberg. To better target adults (other than the ones wolfing down Lucky Charms every morning), General Mills has launched a new product called BFAST, which is a line of nutritional shakes that, according to the company, boasts the “nutrition of a bowl of cereal & milk.” 

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Earnings have been trending upwards over the last 5 years, with revenue moving right along as well.

<table> <thead> <tr><th> </th><th>P/E</th><th>Forward P/E</th><th>Dividend (Yield)</th><th>Beta</th></tr> </thead> <tbody> <tr> <td>GIS</td> <td>18.28</td> <td>17.03</td> <td>1.52 (3.10%)</td> <td>0.02</td> </tr> </tbody> </table>

General Mills looks fairly valued going forward, especially since earnings are expected to continue to rise, and the extra advantage of a high-yielding dividend helps, too.

Cereal king?

Another breakfast provider and cereal company is Kellogg Company (NYSE: K). Kellogg owns iconic cereal brands such as cornflakes. Kellogg is also the global leader in cereal-- with sales topping over $14 billion in 2012. The company is also looking to expand into emerging markets more aggressively, recently focusing in on India with more affordable products such as small packs, as the head of Kellogg marketing in India stated that:

"Small packs are a big growth driver for us. It has expanded our reach and penetration across the country. Going forward, we expect that we will continue to evaluate opportunities and come up with products which are affordable... The ready-to-eat cereal market is around Rs 400 crore. It is growing at the rate of 20-30 per cent."

20-30% growth is great for business, especially in a non-saturated market such as India with a huge population and growing middle class.

Kellogg also wants to expand even further into other breakfast offerings with their Kellogg To Go shakes. The company is also looking to get into other breakfast products, such as hot cereals. As of the company's most recent quarter, the breakfast foods segment grew 1.6%.

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While Kellogg has done a good job of increasing revenues, earnings haven't followed suit, which is why the company looks so pricey in relation to trailing earnings. This is mostly due to one-time events, however, and the company's expected return to its more normalized earnings power should give it a more reasonable valuation going forward: 

<table> <thead> <tr><th> </th><th>P/E</th><th>Forward P/E</th><th>Dividend (Yield)</th><th>Beta</th></tr> </thead> <tbody> <tr> <td>K</td> <td>25.37</td> <td>15.52</td> <td>1.76 (2.70%)</td> <td>0.44</td> </tr> </tbody> </table>

The purest play on cereal...

One of the purest plays on the cereal market is Post Holdings (NYSE: POST), who focuses almost exclusively on ready-to-eat cereals. If you have ever eaten Fruity Pebbles or Honeycomb cereal then you have consumed at least one of the company's products. According to Nielsen, Post's market share was 10.5% for the thirteen weeks ended March 30, 2013. 

Post is also looking to expand and diversify outside of strictly cereal as well, after recently acquiring the branded and private label cereal, granola and snacks business of Hearthside Food Solutions. While Post is just now starting to venture outside of ready-to-eat cereals, General Mills and Kellogg have both already established business in breakfast products other than traditional cereals. The acquisition is supposed to be completed by the end of this month, and should help the company diversify its business and increase market share. The company will also be looking forward to the added revenue, and hopefully higher earnings, after recently reporting a decrease in both gross profit and gross margins. 

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Post has seen not only an uptick in revenues recently, but also in earnings. The problem here is that the stock's price in relation to these increasing earnings looks too expensive both now and going forward, especially without the benefit of a dividend payment for investors:

<table> <thead> <tr><th> </th><th>P/E</th><th>Forward P/E</th><th>Dividend (Yield)</th><th>Beta</th></tr> </thead> <tbody> <tr> <td>POST</td> <td>40.54</td> <td>27.84</td> <td>N/A (N/A)</td> <td>0.944</td> </tr> </tbody> </table>

The bottom line

The consumption of cereal is fairly limited to North America and a few outlying countries such as Australia. Overseas expansion could provide great growth for companies that sell ready-to-eat cereal and other products such as hot cereal. Another source of growth domestically may come from breakfast items targeting adults. Cereal bars and breakfast shakes are being implemented by both Kellogg and General Mills to target this market. Breakfast is usually eaten at home, so food producers have a lucrative market that they can continue to expand and develop with the right products. 

The global breakfast cereal business was worth around $28 billion in 2010, with the ready-to-eat cereal category accounting for over 87% of this segment at $24.5 billion. This overall market is expected to expand to over $34 billion by 2015. General Mills, Kellogg, and Post Holdings are the dominant players in the largest segment of the breakfast market, and are looking to develop breakfast products that also cater more to an adult audience.

While Post is looking way too expensive for my liking, General Mills and Kellogg both look reasonable in relation to earnings going forward. General Mills, however, has the better dividend and lower beta. Low volatility can be seen as a major plus for a consumer staple stock that is usually seen as defensive and "safe" in nature. Global expansion should also provide growth. General Mills looks like the best company to capitalize from this trend, and its low beta and high dividend yield reward investors nicely.

Joseph Harry has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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