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By Eoin Moran

Table of Contents1. Executive Summary..............................................................2

2. Overview...................................................................................3

3. A History of Strong Corporate Governance............................................3

4. Ownership and Current Management..................................................4

5. Rewarding Shareholders.................................................................4

6. Competitor Analysis..................................................................5

7. Medium Term Outlook...................................................................6

8. Quantitative Ramifications..............................................................7

9. Analyst Opinion...........................................................................9

10. Final Reccomendation....................................................................9

11. Appendices..............................................................................10

12. Bibliography.......................................................................13

1

Reccomendation: Long Hold Project X to have positive

impacts

Stalled innovation a

concern amid sluggish

cereal sales

Rising debt levels are

concerning

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

K’s appeal to

shareholders

13 years of successive dividend growth

Source: Bloomberg Terminal

Object 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. Kellogg’s is a member of the “North American Packaged Food Industry”; primarily the ‘U.S Cold

Cereal Market” and the “Global Snacks Industry”. K’s current stock price as of 21 November 2016 is $73.39.

A History of Strong Corporate Governance

Over its long history Kellogg’s has always self-identified as a company of the highest moral and ethical

standards. In a recent interview, current CEO John Bryant, referenced Kellogg’s founder W.K Kellogg, his work

as a philanthropist, and how Kellogg’s as a company aims to embody the value of its founder(Youtube, . These

values are outlined in the company’s 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 company’s 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.

Kellogg’s has featured on Ethisphere’s “World’s 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 company’s 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).

KELLOGG CO. – NOVEMBER 2016 2

Ownership

Kellogg’s ownership structure is unique and is closely linked to their founder, W.K. Kellogg. The company’s

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, Kellogg’s 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 Macy’s 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” (Kellogg’s Investor

Relations, 2016).

Rewarding Shareholders

In 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 Kellogg’s 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

Kellogg’s to undertake another stock split in the near term (Caplinger, 2016).

KELLOGG CO. – NOVEMBER 2016 3

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 Analysis

Per Bloomberg GIC’s classification Kellogg’s 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). Kellogg’s nearest competitor

within the industry is General Mills. Kellogg’s 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 Kellogg’s 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, Kellogg’s 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 K’s competitors. This search for inorganic growth suggests that the opportunities for organic growth

are limited. Kellogg’s however, has historically relied on internal product development to fuel growth. In spite

of this fact, K’s 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)KELLOGG CO. – NOVEMBER 2016 4

Medium Term Outlook

Kellogg’s to be impacted as US Cold Cereals Industry Continues Decline

For almost a century, Kellogg’s 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 (Kellogg’s

newsroom, 2016). The growth in the number of products and market share is one of the company’s 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 Kellogg’s may

miss out as millennials become a key demographic.

Project K to Offset This in the Medium Term

I anticipate project K, Kellogg’s flagship cost saving scheme, begins to reap the rewards it has promised. This is

a flagship strategy which Kellogg’s 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

KELLOGG CO. – NOVEMBER 2016 5

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)

Kellogg’s Recent Borrowing Inflates Debt Leverage

Kellogg’s 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 with Project X. Looking

horizontally, debt leverage in the farm far exceeds that of its closest rivals (General Mills (2.7x) and PepsiCo

(3x)). A major question arising from this is whether Kellogg’s can afford to increase its dividend payout despite

its somewhat worrying debt situation.

Quantitative Ramifications

Income Statement

Revenue

2016 - 2019 1.5%

Assume low demand for cereal sales continues, however it can be anticipated that growth in Asia/Pacific

continues leading to a modest increase in overall revenue.

Gross Profit Margin

Assume increasing use of costly new ingredients (e.g -quinoa) to support product innovation is not sustainable

given they have so far not been met by sales growth as anticipated.

KELLOGG CO. – NOVEMBER 2016 6

Operating Expenses

Efficiency to improve as a result of Project K rollout. Assume operating costs to begin falling through the

remainder of 2016 and into 2017 to the amount predicted by management of $475 million by 2019.

Translating to a $120 million fall in operating expenditure. 120/3500 = -3.5%

Merger/Acquisition Expense

Assume no activity as K maintains current strategy of focus on organic growth through internal innovation.

Cash Flow

Depreciation

Consolidation of factories and production lines to reduce the amount of fixed assets as well as the depreciation which

those fixed assets would incur. Reducing the number of factories through consolidation will thus inevitably push

depreciation associated costs down. To fall in line with the reduction in capital expenditure due to Project K,

anticipate depreciation will fall by 3% annually.

Working Capital

Assume working capital will increase in line with how the industry is moving. K has increased working capital in

5 of the last 7 years. The mean of these 5 increases has been 3% and there is a strong probability that the rate

of increase will be in line with this rate. I assume this is a trend that will continue as K looks to continue look to

increase flexibility across the business model.

Disposal of fixed assets

Anticipate the consolidation of processes outlined in Project K will lead to greater revenue from the disposal of

fixed assets.

KELLOGG CO. – NOVEMBER 2016 7

Balance Sheet

Total Assets

Consolidation as part of Project to lead to an overall fall in level of fixed assets; higher ROA as a result.

Debt

Total debt to fall in line with changes in assets. Future debt levels to fall as Project X spending tapers.

Inventories

Inventories will rise at a slightly higher rate (Currently 4%) due to increases in product innovation and a shift

towards higher quality ingredients.

Analyst Opinion

Shares of Kellogg Co. have been given a consensus recommendation of “Hold” by the nineteen ratings firms

that are covering the firm. One research analyst has rated the stock with a sell recommendation, thirteen have

issued a hold recommendation and five have assigned a buy recommendation to the company (Bloomberg

Terminal, 2016). Many analysts cite Project K as a key determinant in their buy rating. However, despite a

reasonable level of confidence in Kellogg’s management. It is hard to believe Project X alone is sufficient to

overcome the serious structural faults in the cereal market, of which Kellogg’s is so defendant.

Final Recommendation

A major question currently facing management is whether they can continue the trend of raising dividends in

spite of the increased debt as a result of project X. Failure to do so could seriously hamper company

reputation and medium term prospects. My HOLD recommendation is largely formed from the assumption

that Kellogg’s strong management team will continue to increase dividend payout to shareholders and will

work to reduce debt levels upon the completion of Project X. It also imperative that they build on growth

within the global snack industry, amid weaknesses in their primary market; cold cereals market.

KELLOGG CO. – NOVEMBER 2016 8

Appendices

Appendix 1: North America Packaged Food Industry – Market Share by Sales (2011-2016)

Source: Bloomberg Terminal

Appendix 2: Breakfast Cereal Sales – Change in Consumption (2003-2013)

Source: Euromonitor (http://www.euromonitor.com/breakfast-cereals)

Appendix 3: Largest Cold Cereal Brands – 4Q16

KELLOGG CO. – NOVEMBER 2016 9

Source: Brandon Gaille (http://brandongaille.com/27-stunning-cereal-industry-trends/)

Appendix 4: The Kellogg Co’s Largest Shareholders (As of 18 November 2016)

Source: Bloomberg Terminal

Appendix 5: Historical Stock Splits

Source: Kellogg’s Investor Relations (http://investor.kelloggs.com/stock-information)

Appendix 6: Dividend Growth (1965-2015)KELLOGG CO. – NOVEMBER 2016 10

1965 1975 1985 1995 2005 20150

0.5

1

1.5

2

2.5

0.03 0.09

0.23

0.75

1.06

1.98D

ivid

end

($)

Source: Data taken from Kellogg’s Investor Relations (http://investor.kelloggs.com/dividends#chart)

Appendix 7: 2020 Growth Plan

Source: Kellogg’s Investor Relations (http://investor.kelloggs.com/stock-information)

Appendix 8: Project K Outline

KELLOGG CO. – NOVEMBER 2016 11

Source: Kellogg’s “Visibility into the future presentation (Slide 72) (http://investor.kelloggs.com/~/media/Files/K/Kellogg-IR/reports-and-presentations/2016/2016-cagny-presentation.pdf)

KELLOGG CO. – NOVEMBER 2016 12

Sources

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Retrieved on 16 Nov. 2016 from https://www.youtube.com/watch?v=m0JXiMjpvbE

2. "Honorees". Ethisphere Institute | “Good. Smart. Business. Profit.” N.p., 2016. Retrieved on 16 Nov.

2016 from http://worldsmostethicalcompanies.ethisphere.com/honorees/

3. Evans, Will. "Beware Of Corporate Consulting Firms Offering Awards For Corporate Ethics.". Slate

Magazine. N.p., 2016. Retrieved on 16 Nov. 2016 from

http://www.slate.com/articles/business/moneybox/2010/03/its_all_good.html

4. "Kellogg To Buy Controlling Shareholder Of Brazil's Parati Group". Reuters. N.p., 2016. Web. Retrieved

on 19 Nov. 2016 from http://www.reuters.com/article/kellogg-ma-ritmo-idUSL4N1CJ3QN

5. "Breakfast Cereal And The Breakfast Food Market - Stealing Share". Stealing Share. N.p., 2016. Web. 21

Nov. 2016 from http://www.stealingshare.com/pages/breakfast-cereal/

6. "Kellogg's Recipe Of Ethics, Social Responsibility Feeds Profits". TheStreet. N.p., 2016. Retrieved on 21

Nov. 2016 from https://www.thestreet.com/story/12537553/2/kelloggs-recipe-of-ethics-social-

responsibility-feeds-profits.html

7. Rooney, Ben. "Kellogg Co. Is The Second Big Cereal Company To Unveil New Sustainability Goals"

CNNMoney. N.p., 2016 Retrieved on 19 Nov. 2016 from

http://money.cnn.com/2014/08/13/news/companies/kellogg-sustainability-goals/index.html?iid=EL

8. "Kellogg U.S. Brands Launch New Delicious Breakfast And Snack Choices". Kellogg Company News

Room. N.p., 2016. Web. Rettrieved on 21 Nov. 2016 from

http://newsroom.kelloggcompany.com/2016-05-02-Kellogg-U-S-Brands-Launch-New-Delicious-

Breakfast-and-Snack-Choices

KELLOGG CO. – NOVEMBER 2016 13

9. Caplinger, Dan. "Kellogg Stock Split: Will The Food Giant Split Soon? -- The Motley Fool". The Motley

Fool. N.p., 2016. Retrieved on 18 Nov. 2016 from http://www.fool.com/investing/2016/11/15/kellogg-

stock-split-will-the-food-giant-split-soon.aspx

Additional Resources Used

1. Bloomberg Terminal

2. "Investor Relations". Investor.kelloggs.com. N.p., 2016. Web. Domain accessed on 15-22 Nov. 2016.

KELLOGG CO. – NOVEMBER 2016 14