Kellogg's Company Paper

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Kellogg Co.

Table of ContentsExecutive Summary2Overview3A History of Strong Corporate Governance3Ownership and Current Management4Rewarding Shareholders4Competitor Analysis5Medium Term Outlook6Quantitative Ramifications7Analyst Opinion9Final Reccomendation9Appendices10Bibliography13

Reccomendation: Long Hold Project X to have positive impacts Stalled innovation a concern amid sluggish cereal sales Rising debt levels are concerning

Executive Summary

Competitive Landscape High level of deal activity as organic growth opportunities remain low North America packaged food sales continue to stall Reliance on Walmart Stores Inc. (WMT) as key customer poses risk

Dividend Growth (2011-2016) Continual annual dividend growth a key element of Ks appeal to shareholders 13 years of successive dividend growth

Source: Bloomberg Terminal

Performance 5 year Performance (2011 - 2016) 12 Month Performance (Nov. 2015 - Nov. 2016) Source: Kelloggs Investor Relations (http://investor.kelloggs.com/stock-information#stock-chart)

Key ratios (2015) Source: Bloomberg Terminal

2

Overview Kellog Co. (Ticker: K) is the eight largest North American packaged-food company based on sales (Appendix 1). It supplies ready to eat cereals and snacks to over 180 countries (Bloomberg, 2016). Historically it has been solely a member of the dry cereal industry holding well-known names in the industry such as Corn Flakes and Special K. Kelloggs is a member of the North American Packaged Food Industry; primarily the U.S Cold Cereal Market and the Global Snacks Industry. Ks current stock price as of 21 November 2016 is $73.39.A History of Strong Corporate GovernanceOver its long history Kelloggs has always self-identified as a company of the highest moral and ethical standards. In a recent interview, current CEO John Bryant, referenced Kelloggs founder W.K Kellogg, his work as a philanthropist, and how Kelloggs as a company aims to embody the value of its founder(Youtube, . These values are outlined in the companys 56 page Global Code of Ethics, which was most recently updated in 2013. The doctrine is based around 6 key values (integrity, accountability, passion, humility, simplicity) and 5 core principles which outlines the companys responsibility to their key stakeholders (our people, our consumers, our marketplace, our investors, our communities). Most recently, In 2014, Kellogg announced new global sustainability goals in responsible sourcing and the conservation of natural resources. The company also continued progressing against its hunger relief pledge to donate 1 billion servings of food through Breakfasts for Better Days.Kelloggs has featured on Ethispheres Worlds Most Ethical Companies List each year since 2011 (Ethisphere, 2016); though the legitimacy of this list has been called into the question in the past (Evans, 2016). The companys efforts has also been noted on Wall St. In 2014, The Street lauded their efforts to utilize corporate social responsibility in a profitable manner (Courtenay, 2014).Ownership Kelloggs ownership structure is unique and is closely linked to their founder, W.K. Kellogg. The companys largest shareholder, at 19.5%, is the W.K Kellogg Foundation; which was established in 1930 to promote the welfare of children (Figure 3). As a result of their unique structure, Kelloggs is one of the few industry leaders not publicly targeted by activist shareholders in recent years. Taken in the context of the industry this is somewhat surprising as net income has declined by ~3% since 2010. (Bloomberg, 2016)

Current Management John Bryant became President and CEO of the company in 2011. On July 1 2014 he added the responsibilities of chairman of the executive board thus creating a situation of dual leadership. In spite of this, the market reacted positively to this news, illustrating that he is liked by shareholders (the market marginally ticked upwards (+0.45%) the day this was announced). Bryant is highly valued in the firm, having joined the company in 1998. He also currently sits on the Macys board of directors. The company is currently without a CFO after the retirement of Ronald Dissinger in May 2015, the search for a replacement is ongoing (Kelloggs Investor Relations, 2016).

Rewarding ShareholdersIn the medium term, shares have generated a total return of 91% since 2010, marginally underperforming the S&P 500 (95%) for the same period. Historically, stock splits and dividend payouts have been the primary ways in which Kelloggs has created value for its shareholders. The company has undertaken seven 2:1 stock splits in the past, with the most recent of these occurring in 1997. Certain analysts have touted that they expect Kelloggs to undertake another stock split in the near term (Caplinger, 2016). Dividends have been increased on an annual basis every year since 2003, a trend which has continued into 2016. These consistent, gradually growing, long term returns are valued by institutional investors as 65.5% of the company is owned by this investor class. This steady rise can be seen in Appendix 6.

Competitor AnalysisPer Bloomberg GICs classification Kelloggs is a member of the North American Packaged Food Industry, of which it holds a 4.6% share; down from 5.3% in 2011 (Appendix 2). It is the market leader of the U.S. Cold Cereal Market subindustry holding a 32.2% share in 2015 (Bloomberg, 2016). Kelloggs nearest competitor within the industry is General Mills. Kelloggs currently holds just 1 of the top 5 most popular cold cereal brands, with General Mills holding the other 4. (Appendix 3). This industry has performed poorly in recent years due to waning consumer demand for cereal products. All types of cereals have slumped significantly in recent years with the exception of muesli (Appendix 4). As a result of this fall in cereal sales Kelloggs has shifted long term strategic direction in recent years with a focus on capturing market share from the highly competitive but lucrative Global Snacks industry which is dominated by market leader Pepsi Co. (29.0%). Per Bloomberg, Kelloggs has been successful in increasing its share of the industry which has grown from .67% in 2011 to 2.38% currently (Appendix 5). Analysis of the Packaged Foods Industry competitive landscape highlights significant M&A activity among Ks competitors. This search for inorganic growth suggests that the opportunities for organic growth are limited. Kelloggs however, has historically relied on internal product development to fuel growth. In spite of this fact, Ks R&A spending is in line with competitors. Kellogg's research & development spending as a percentage of sales of 1.4% is in line with that of its close competitors Campbell Soup (1.5%), General Mills (1.3%) and PepsiCo (1%) (Bloomberg, 2016). failure to invest while others are growing inorganically means the company could lose market share. The one divergence from this strategy has been the recent, somewhat minor acquisition, of Brazillian salty snack firm Parati, in October 2016 (Reuters, 2016)Medium Term OutlookKelloggs to be impacted as US Cold Cereals Industry Continues DeclineFor almost a century, Kelloggs defined the American breakfast. However, this landscape has been changing. Consumption of cold breakfast cereals has been dropping at a rate of 1% per annum for the last decade (Stealing Shares, 2015). Consensus predictions place cold cereal sales to fall at a rate of as much of 2% annually (Bloomberg Terminal). This shift in demand has been caused my millennials favoring healthier, more convenient options. Although, the cold cereal market industry is a historically moderately growing sector, this negative growth rate is unprecedented. The Company announced in late June it will introduce more than 40 new products to its U.S. cold cereal lineup this year that will match trends linked with both nutrition and convenience. A key focus will be on producing organic products. Special K Multigrain Crackers with Quinoa and MorningStar Farms Veggie Breakfast Sausage & Grain Patties are two of their newest releases and underline this trend (Kelloggs newsroom, 2016). The growth in the number of products and market share is one of the companys key drivers in the medium term (Appendix 7)None of these products have yet gained any serious traction suggesting the company is stifled by a lack of creation. There is every indication that this is an industry which will continue to decline and Kelloggs may miss out as millennials become a key demographic. Project K to Offset This in the Medium TermI anticipate project K, Kelloggs flagship cost saving scheme, begins to reap the rewards it has promised. This is a flagship strategy which Kelloggs has pushed onto shareholders. Management have stated that current expenditure cost saving will be in the region of $450-500 million (Appendix 6). This will primarily be achieved through the consolidation of factories and production lines. This will also lead to significant reduction in capital expenditures as expenditure on the scheme tapers (currently Project K accounts for 75% of capital expenditure) and reductions in expenditure. This will have obvious implications on net income. Project K has already had success indicating future successful implication is probable: As a 2014 CNN article outlines; The Eggo factory recently installed "fuel cell technology" that supplies half of its annual energy needs and consumes less water than it would if it were connected to the energy grid. (Rooney, 2014)Kelloggs Recent Borrowing Inflates Debt LeverageKelloggs most recent debt leverage, as measured by 12-month total debt-to-Ebitda was 4.5x at the end of 3Q16. This is far higher than its unadjusted level over the past 5 years (4.1x).This represents a significant 31% increase in debt driven by the minor acquisition of Parati, and costs associated