Kellanova: A Tasty Opportunity Considering Hidden Growth (NYSE: K)

In early October 2023, I wrote an article about the separation of the company formerly known as Kellogg. Eventually, the company split into two separate businesses. One of them is now known like WK Kellogg Co (KLG), which is the company that now serves as the former conglomerate’s North American grain operation. The other company that spun off became known as Kellanova (NYSE:K). It also emphasizes the global snacks business, as well as some key growth markets, of brands previously owned by Kellogg.

In this article, I explained why Kellanova represents an attractive opportunity for investors. Some key brands owned by the company are experiencing attractive growth. Furthermore, the global snack market is attractive in itself. Actions of the company, while not exactly cheap, was trading near the bottom of the scale compared to similar companies. Ultimately, this led me to label the company a “buy.” In some ways, things went pretty well. Shares are up 16.2% since then. But relative to the broader market, the company has underperformed, as evidenced by the fact that the S&P 500 is up 26.1% over the same period.

As disappointing as this underperformance is, the company is starting to show real signs of progress. There is still a lot to do. But while management is now looking to the future and looking for ways to capture additional value in the future, and the shares still trade near the lower end of the spectrum compared to peer companies, I believes that keeping the company in the “moderate buy” category only increases. meaning at that moment.

More and more tasty

The purpose of this article is not to revisit the details of my October 2023 article. However, I think a brief description of Kellanova and its operations is in order. Operationally, the company is a truly global player, but it emphasizes two main product types. It mainly focuses on catering to the global snacks market. According to the most recent quarter data, approximately 63% of total revenue comes from snack-related products. Examples include Pringles, Cheez-It, Parati, etc. The rest of its revenue is split between international grain operations, frozen foods, noodles and other related products. In total, about 80% of its revenue comes from either the global snack business or all of its miscellaneous products that are sold to emerging markets. The beauty of this type of business model is that the snack market and just about anything related to emerging markets is expected to see attractive growth relative to most other sectors of the food industry.

Over the past few years, management has experienced attractive revenue growth. From 2021 to 2023, the revenue made by Kellanova managed to increase from $11.75 billion to $13.12 billion. This represents an annualized increase of approximately 5.7%. Interestingly, revenue growth would have been even more impressive without foreign currency fluctuations. There would have been no change in sales in 2021. However, on an organic basis, revenue for 2023 was $13.64 billion. This brings the company’s annualized growth rate to approximately 7.7%. Much of this expansion appears to be coming from the snack market. In North America, for example, sales linked to organic snacks jumped 4.7% between 2022 and 2023. But in Europe, where the company generates around 16% of its turnover, sales linked to snacks rose 17%. In Latin America, the company enjoyed an organic growth rate in this category of 6.8%. And in the AMEA (Asia, Middle East and Africa) regions, revenue jumped 15.6%. That’s not to say the company hasn’t benefited from other categories. In Latin America, for example, revenues from organic cereals increased by 9.4%. And in AMEA regions, organic sales increased by 24.4%.

I wish I could say that earnings and cash flow followed a similar trajectory, but that wouldn’t be a correct statement. Even if we exclude revenue from discontinued operations, we would have seen net income fall from $1.10 billion to $775 million during this period. To be completely fair, this is partly due to rising interest costs, but also other miscellaneous income and expense items that have impaired profitability over the years. If we look at operating income alone, we would have seen an increase from $1.38 billion to $1.51 billion during this period. Other profitability measures failed to impress. Operating cash flow increased from $1.70 billion to $1.65 billion. Even if we adjust for changes in working capital, we would have seen a decrease from $1.70 billion to $1.62 billion. The only real improvement came from EBITDA. It managed to grow from $1.85 billion to $2.04 billion.

When looking at the data covering fiscal year 2024, we only have the first quarter results. And at first glance, it may also seem uninteresting. The company’s revenue actually declined year over year, from $3.34 billion to $3.20 billion. But even that requires some adjustment. If we take into account a sale made by the company last year, the basis would be slightly lower, at $3.32 billion. And when currency fluctuations are taken into account, sales this year would have been just under $3.50 billion. This represents an organic growth rate of 5.4% over one year. According to management, although product volume declined, the company enjoyed an 8.5% increase attributable to a combination of pricing changes and changes in product mix.

Ultimately, this is where we see the real improvements. Although official revenues fell, the company’s profitability improved, with net income increasing from $230 million to $267 million. This is after adjusting for the discontinued operations mentioned above. This was largely due to the company’s increased operating profit. According to the data provided, the company’s gross profit margin increased from 29.4% last year to 32.2% this year. Using this disparity with revenues earned in the first quarter of 2024, this implies additional pre-tax profit for shareholders of $89.6 million. This makes sense when you consider the impact that higher prices typically have on low-margin businesses.

On top of that, it’s worth noting that the company’s operating profits would have been even higher without other factors. Most notably, in the first quarter of this year, the company spent $101 million on network optimization activities. This is essentially restructuring operations following the spinoff in order to reduce costs over the long term. Instead of the 16.1% increase in profitability that I calculated, if the company had been able to report adjusted operating profit numbers, we would have seen a 29.5% increase in operating profit year over year. Other profitability metrics for the company also improved. Operating cash flow, for starters, increased from $276 million to $364 million. If we adjust for changes in working capital, we get an increase of $404 million to $638 million. And finally, the company’s EBITDA increased from $462 million to $539 million.

Management expects organic revenue to grow about 3% this year. So it doesn’t appear that the first quarter alone is the only period in which the company’s results will be better year over year. Adjusted earnings per share are expected to be between $3.55 and $3.65. That’s more than the $3.23 per share reported for 2023. That would imply adjusted earnings of about $1.24 billion. Management also said operating cash flow is expected to be around $1.7 billion this year. This should result in EBITDA of approximately $2.14 billion.

In the chart above, you can see how these estimates for 2024 and historical results for 2023 give an idea of ​​the company’s valuation. It’s not exactly cheap, but for a high-quality food operator, it’s attractive. In the table below, I then compared Kellanova to five similar companies. On a price-to-operating cash flow basis, two of the five companies were cheaper than it. But when it came to the other two profitability metrics, only one of the five companies was cheaper than our prospect.

Business	Prizes/Winnings	Price/Operating Cash Flow	EV / EBITDA
Kellanova	15.7	12.5	12.8
Tyson Foods (TSN)	54.9	9.1	23.6
McCormick & Company (MKC)	26.4	14.7	18.2
Hormel Foods (HRL)	21.9	13.2	14.5
Conagra Brands (CAG)	14.7	7.7	12.2
Mondelez International (MDLZ)	21.5	18.8	13.4

Click to enlarge

Before concluding this article, I would like to briefly touch on what other sources think of Kellanova. In the image below you can see how the stock is rated according to not only the analysts who write for Seeking Alpha and Wall Street analysts, but also according to the Quant Rating system that Seeking Alpha has established. Compared to other players, Kellanova’s overall rating is decent, but far from great. Certainly, the leader of the pack would be Mondelez International, followed by Tyson Foods. Kellanova, meanwhile, would be tied with McCormick & Company and Conagra Brands for third place.

In the following image below you can see how different aspects of the business are weighted by the Quant Rating system. In terms of valuation, the company is okay, but not great. And it’s actually pretty good when it comes to profitability, momentum, and EPS revisions. But where it appears really weak is on the growth side. Without it, it would appear that only Tyson Foods would be rated higher than Kellanova currently is. However, as I have demonstrated, you have to dig under the hood for this growth. Actual organic revenues were overshadowed by foreign currency fluctuations and other factors. When we take this into account, we see that the company’s growth is quite solid. This is particularly true in terms of financial results, with profits growing by double digits.

Take away

From what I can tell, Kellanova is doing some pretty good work right now. Is there room for improvement? There certainly are. But considering how the stock is valued relative to similar companies and how the company performs when you strip away all the noise, I think a moderate “buy” rating makes perfect sense at this stage.