March 6, 2019

Kellogg Company | Update 2

In our latest report on Kellogg Company we are reiterating and updating our thesis based on Kellogg’s Q4 18 results and FY 19 guidance.

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We continue to believe Kellogg (1) will be forced to cut its dividend or lose its credit rating and (2) will again miss and/or need to reduce FY 19 guidance.

Moreover, after Kraft Heinz’s (“KHC”) recent disastrous results and dividend cut, we are even more convinced that it’s only a matter of time before K follows suit as K is less profitable and more financially strained by comparison.  K’s new disclosures and persistent deceptive tactics reinforce our expectations for more pain to be inflicted on K shareholders.

We remain short shares of K with a target price of $39.50.

Prescience Point Opinions:

  • KHC’s recent debacle should terrify K shareholders; K is in much worse shape but has been able to hide behind aggressive financial engineering: On 02/21/19, KHC announced (1) very poor Q4 18 results and FY 19 guidance, (2) a dividend cut, (3) a $15.4 billion impairment, and (4) receipt of an SEC subpoena.  In response, KHC shares traded down over 27.0% and it was put on negative credit watch by S&P.  We believe K will share the same fate as it is not only less profitable and more financially strained than KHC but has weaker corporate governance and has concealed severe deterioration using accounting gimmicks.  K’s premium equity valuation and better credit ratings relative to KHC are unwarranted.
  • Guidance for strong second-half in FY 19 is setting shareholders up for more disappointment: K continues to kick the can down the road while management is still not being forthright with shareholders. Sell-side analysts continue to anchor expectations to K’s overly optimistic guidance, setting investors up for more disappointment, especially as accounting excesses “un-wind.”
  • New Risk Factor confirms “un-wind” of DSO & DPO build will wreak havoc on performance: K added a new Risk Factor in its FY 18 10K that corroborates the working capital “un-wind” will lead to a financial reckoning.
  • K is not the dividend stalwart shareholders believe it to be; cash is extremely tight and risk of a dividend cut or credit downgrade is high and rising:  K doesn’t generate enough cash to cover dividends and short-term obligations.  As a result, we believe K’s recently announced asset sales are not opportunistic, but necessary to fund buybacks, pay dividends, and shore up the balance sheet.
  • Shares are trading at an unjustifiably high valuation:  Based on our adjustments, K is trading at 15.4x NTM P/E and 12.7x EV/EBITDA vs. KHC at 11.1x and 10.6x, respectively.  Further, K’s adjusted leverage ratio of 4.4x remains in-line with high yield CPG peers.  We reiterate our K price target of $39.50.  Shares still have ~30% downside.

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