Good Dividend, Recession Proof
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With a company like Kellogg (NYSE: K) investors have become accustomed to consistent performance. Peter Lynch once referred to Kellogg as a good place for investors to hide out if they feared uncertainty in the economy. He specifically said while people may cut back on other expenses they don't eat less cornflakes. While Kellogg is certainly more than just cornflakes, the company's earnings report shows challenges that it will probably take a few years for the company to recover from. That being said, for income investors the company pays a respectable yield, while giving the chance for a capital gain.
Kellogg's faces competition from two well-known companies, as well as a myriad of private label brands as well. The one advantage that the company has is its iconic brand names. While other companies are being affected by private label sales, Kellogg seems to maintain stability through the taste difference of their name brands. A perfect example is the Pop Tarts brand, which is well loved by both adults and kids. Though there are many other companies that produce similar products, Kellogg has continually introduced new flavors to keep the brand fresh. With the company's recent acquisition of Pringles from Procter & Gamble, the company added another iconic brand to its stable. While Pringles is expected to be a future growth driver, another area of growth for the company could be the expansion of its Kashi line of organic foods. Kellogg's competitor General Mills (NYSE: GIS) also carries a fairly well-known organic brand in the Cascadia Farms name. Ironically, Kraft Foods (NASDAQ: KRFT) does not have an organic brand of note. Since organic sales are growing faster than traditional foods, this is a competitive advantage that Kellogg and General Mills can exploit. While none of these three companies could be considered as a huge growth story, each one is expected to grow between the high single digits to low double digits over the next few years. So the question is, why should investors consider Kellogg?
Looking at the company's most recent earnings report, we get a sense of the growth possible as well as the challenges the company is facing. Kellogg essentially reports in two different divisions: one covering North America, and one representing international results. In the North American division, net sales increased 5.9%, and the company saw positive volume growth. Specifically the company's cereal business and Kashi food line were strong points. The company also saw, “significant growth” in the Pop Tarts business. Kellogg's U.S. snacks business was also strong with 4.1% growth in internal sales. These multiple positives led the North American division to report operating profits up 4.8%. However, for every positive in North America the international division showed a negative.
Not only did international net sales decline 3.8%, but operating profit plunged 30.9%. The company specifically said that weakness in Australia and their results in Europe led to this operating profit drop. Even sales in the Asia-Pacific region declined 2%, the company noted that this decline was primarily due to Australia, and excluding this factor the region would have seen growth. A lone bright spot was the company's Latin American business which reported net sales growth of 6.8%. Primarily due to the challenges in the international division, the company's financial reports were not as good as they would have been otherwise.
There were multiple moving parts to the company's reported earnings and cash flow figures. The company invested in their supply chain, as well as paid for transaction and integration costs from the Pringles acquisition. That being said, operating profit declined 10.7% which was nearly identical to 10.6% decline in reported EPS. However, free cash flow for the first half of 2012 was actually up 30.27% on a year-over-year basis. In addition, the company decreased its diluted share count by 1.91% versus last year. Since the company's dividend of nearly 3.5% is one of the main attractions to the stock, investors should be happy to know that the free cash flow payout ratio over the first six months was just over 58%. This would seem to indicate the company's dividend is not only safe, but has room to grow in the future. Speaking of the future, what should investors expect from Kellogg going forward?
The company's guidance was for full-year sales growth between 2% and 3%. However, the company expects operating profit to decline 2% to 4%. Guidance for earnings per share came in at $3.18 up to $3.30 for the full year. This means based on the company's worst case scenario, the stock sells for just over 16 times full-year estimates. With analysts calling for future growth of 6.5%, a lot will depend on how things develop internationally. Given that Kellogg saw current earnings hurt due to their international results, any improvement overseas should also help the company's growth rate. Competitor General Mills offers a similar yield, slightly higher growth rate, at a lower P/E ratio. The biggest difference between the two companies is Kellogg's acquisition of Pringles. This brand gives Kellogg an additional growth driver that the company did not have previously. If the company can leverage multiple Pringles flavors in the way they have with Pop Tarts, this could be significant. However, for investors looking for slightly better growth, Kraft Foods could be an attractive choice. This company is expected to grow EPS by roughly 11% and currently yields about 2.8%. This gives Kraft a higher combined return than either Kellogg or General Mills. That being said, any of these three choices offer income hungry investors a respectable dividend with low volatility.
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