It’s either going to be looked back on as an incredibly brilliant decision, or an incredibly bad idea. There’s not much potential for an middling outcome with the latest acquisition by Kellogg Company (NYSE:K), especially considering the company is scaling back on its buyback program of Kellogg stock to ensure it’s got enough liquidity for the foreseeable future.
The target is Brazilian food company Parati Group, which makes (among other things) biscuits, powdered beverages and pasta. Although Kellogg already has exposure in the important Latin American market, the deal will greatly magnify its presence in South America in one fell swoop.
The buyout, however, forces owners of K stock to ask if Kellogg is getting a bargain with Parati, or if there’s a reason the company can buy Parati so cheaply.
Deal Details
Kellogg Company isn’t acquiring Parati Group directly. Rather, it’s buying Ritmo Investimentos, which is a controlling shareholder of Parati Group. The effect is essentially the same as a purchase of Parati, however. The final price tag comes to $429 million — all cash — to get the deal done, versus annual net sales of around $190 million for Parati.
The buyout isn’t expected to significantly alter the expected profits for K shares in 2016 and 2017, but should start to drive a fiscal benefit beginning in 2018.
Kellogg Company CEO John Bryant had this to say:
“With its outstanding portfolio of popular consumer brands, Parati Group is an excellent strategic fit for Kellogg and our business in Latin America. Brazil is the largest economy in Latin America and this acquisition will allow us to accelerate our growth and improve our margins in the region. This means more growth for the core Parati Group business and our well-loved Kellogg brands.”
The Parati Group acquisition marks the fourth major emerging market acquisition in just the past couple of years, underscoring one of the company’s recently-stated ambitions. That expansion isn’t materializing without some sort of cost, however.
Kellogg Company can certainly afford the purchase, tapping into the $531 million it’s currently got in the bank. It’s dialing back the $700 million to $750 million buyback of Kellogg stock, though, to a range of only $450 million to $550 million.
It’s also worth noting the company’s long-term debt has grown from $5.2 billion as of late 2015 to $6.3 billion as of the most recent look, ramping up recurring non-operating expenses as it’s made recent deals.
Timing Is Half the Battle
Capitalization questions aside, Kellogg is setting itself up to be a hero or a goat with the acquisition of the Brazilian-based company.
The Latin American nation has been plagued by more than its fair share of weakness of late. As of the second quarter of this year, Brazil’s GDP shrank for a sixth straight quarter. Inflation has been rampant there too, ramping up to a whopping annualized rate of 8.97% in August. Unemployment is at a painfully high 11.8% as of the most recent look, stifling consumer spending.
While it is true that consumer staples don’t suffer to the same degree as cyclical companies might when an economy is in the doldrums, when the situation is as dire as it still is in Brazil, few industries truly thrive.
Kellogg, however, may be pulling the trigger at an ideal time.
Though plenty of doubters remain, and though the deterioration of the economic data may be slowing only because the economic situation (literally) can’t get any worse in Brazil, some green shoots are starting to sprout.
As Investec’s Mike Hugman assessed it:
“We are cautiously optimistic on Brazil over the medium term and have a modest overweight as part of a general tilt toward Latin America. We do not believe [new President] Temer will be able to pull off an economic miracle, but we do believe the economy is at a turning point and will gradually improve over time.”
If Hugman is right, Kellogg is getting in at the right time at a palatable price — Parita is being acquired for only 2.25 times its revenue.
Bottom Line for Kellogg Stock
When all’s said and done, the non-response from Kellogg shares today (the 1% dip is more market-driven than company-specific) is arguably the “right” response. Parita Group is a decent addition for Kellogg, but it’s not necessarily going to become a high-octane growth engine for the new parent company … at least not yet.
Indeed, though Kellogg can technically afford to purchase Parita, owners of K stock may want to keep a watchful eye on the company’s cash and debt levels. Neither are in red-alert territory, but problems can have a way of quietly sneaking up on a company.
More purchases like the one announced today may well do more harm than good if Kellogg can’t actually create significant synergies, and so far, we’ve not seen too much of that with the other three emerging market buyouts made in the past couple of years.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
