Kellogg Shares — 3 Pros, 3 Cons

by Tom Taulli | February 16, 2012 11:06 am

Kellogg Shares — 3 Pros, 3 Cons

kelloggs Kellogg Shares — 3 Pros, 3 ConsThanks to an accounting scandal[1], Diamond Foods (NASDAQ:DMND[2]) had to nix its deal to buy Pringles from Proctor & Gamble (NYSE:PG[3]). But Diamond’s loss is Kellogg‘s (NYSE:K[4]) gain. On Wednesday, Kellogg swooped in and agreed to purchase the snack business for $2.7 billion[5], sending K shares up 5.1% amid a broader market selloff. The run-up has helped Kellogg gain ground after seeing its stock decline roughly 10% since late-October peaks.

So is it time to get bullish on Kellogg? Here’s a look at the pros and cons:

Pros

The Pringles Deal: It looks like a smart one. The snack business has relatively higher margins than the cereal segment. The deal is expected to vault Kellogg into the No. 2 spot in the snack category, with PepsiCo (NYSE:PEP[6]) (and its Frito-Lay division) on top. Kellogg will benefit from growth opportunities in Asian markets and should be able to get substantial cost savings.

Great Portfolio: Kellogg already boasts iconic brands like Corn Flakes, Rice Krispies and Eggo. There is little evidence of weakness in the product line. In fact, Kellogg’s already strong snack brands — like Keebler, Cheez-It and Kashi — also should benefit from the Pringles acquisition in areas such as overseas distribution.

Innovation: To maintain strength in its brands, Kellogg has focused on evolving its products with better packaging and flavors, among other improvements. For example, Kellogg has launched six products for its waffle lines, as well as four new meals for Kashi Steamed Meals, which can be prepared in minutes but still have a great taste and nutritional value.

Cons

Europe: This market has remained a major drag on Kellogg amid the continuing debt crisis and slowing growth. And with Greece still suffering through sovereign debt issues[7], it looks like Europe’s problems could persist for some time.

Supply Chain Issues: More than a year ago, Kellogg had to recall various cereals because of foul odors, and has since heavily invested in its supply-chain infrastructure. In the long run, this will reap benefits, but it has negatively impacted margins.

Commodity Inflation: This remains a problem for Kellogg — and most other food companies. True, Kellogg has tried to find ways to lower its cost structure, such as with a push into digital marketing (which seems to be cheaper than traditional approaches). However, the savings likely won’t be enough to offset the increase in the costs for raw materials.

Verdict

Kellogg’s strategy has been spot-on. The company is making the necessary investments in its supply chain and brand innovation. It also is benefiting from social media like Facebook and Twitter.

For the next couple years, the Pringles deal should be transformative, likely boosting overall margins and growth. And Kellogg ultimately could end up buying Diamond Foods, which would add brands like Kettle chips and Pop Secret popcorn to its growing stable of snacks.

For now, the pros outweigh the cons on Kellogg stock.

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling”[8] and “All About Commodities.”[9] Follow him on Twitter at @ttaulli[10]. As of this writing, he did not own a position in any of the aforementioned securities.

Endnotes:
  1. an accounting scandal: http://investorplace.com/2012/02/is-diamond-foods-dmnd-the-next-worldcom/
  2. DMND: http://studio-5.financialcontent.com/investplace/quote?Symbol=DMND
  3. PG: http://studio-5.financialcontent.com/investplace/quote?Symbol=PG
  4. K: http://studio-5.financialcontent.com/investplace/quote?Symbol=K
  5. agreed to purchase the snack business for $2.7 billion: http://investorplace.com/2012/02/diamond-foods-procter-gamble-kellogg-dmnd-pg-k-pringles-deal/
  6. PEP: http://studio-5.financialcontent.com/investplace/quote?Symbol=PEP
  7. Greece still suffering through sovereign debt issues: http://investorplace.com/2012/02/greece-will-she-or-wont-she-austerity-bill/
  8. “All About Short Selling”: http://www.amazon.com/All-About-Short-Selling/dp/0071759344/ref=sr_1_1?s=books&ie=UTF8&qid=1302184310&sr=1-1
  9. “All About Commodities.”: http://www.amazon.com/All-About-Commodities/dp/0071769986/ref=ntt_at_ep_dpi_10
  10. @ttaulli: https://twitter.com/ttaulli

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