A Rare Bargain in the Packaged Food Aisle

Erin Lash: We’ve long held that the merits of Kellogg’s move away from direct-store distribution (in favor of warehouse delivery) in 2017 would prove advantageous. But the market has been more skeptical, with shares edging up less than 3% between January and July 2019, versus a nearly 20% appreciation in the Consumer Staples Index over the same period.

From our vantage point, this divergence reflects Kellogg's failure to boast an improving top line as of yet (unlike peers). However, with its revised strategic playbook, we think Kellogg is poised to crack the code on profitable and sustainable sales growth.

For one, although its U.S. cereal business (which accounts for one fifth of sales in aggregate) has been fighting an uphill battle, we believe the market fails to appreciate the attractive dynamics of its vast snacking mix (which accounts for 50% of sales). Further, changes to its pack formats to include more on-the-go offerings should allow for increased penetration in alternative outlets.

We also think recent acquisitions (including smaller niche startups like RXBAR) afford the opportunity to grease the wheels of its own innovation cycle to more nimbly respond to ever-changing consumer trends, particularly as it relates to health and wellness, and taste. By abandoning direct-store distribution, Kellogg stands to elevate brand spend, rather than expending resources on its distribution footprint, to support its entrenched retail relationships--which we view as key in the intensely competitive landscape in which it plays. And we expect efficiencies will remain a pillar to fuel these investments while also aiding profits.

With a 4% dividend yield and trading at a 20% discount to our $78 fair value estimate, investors should consider buying shares in this wide-moat name, a rare bargain in the packaged food aisle today.