Thursday, October 22, 2009

Kellogg Company– Stock Analysis for Dividend Portfolio

Kellogg Company (K) is a leading producer of ready-to-eat cereal, and also sells convenience foods such as cookies, crackers, cereal bars, fruit snacks, and frozen waffles.

For starter, K is neither a Dividend Aristocrat nor member of Broad Dividend Achiever. This is primarily because it had flat dividends between 2001 and 2004. However, it has paid consistent and stable dividends (without cutting) since 1985. The most recent dividend increase was in August 2009. My objective here is to analyze if how it rates on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 9 years of company’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

  • Revenue: In general, a growing trend since 2002. The average revenue growth for last 9 years has been approximately 7.3%. The company raised the year 2009 revenue estimate.
  • Cash Flows: Overall, a very slow and anemic increasing trend of free cash flow and operating cash flow. FCF is more or less similar to net income, but 2008 FCF was 80% of net income.
  • EPS from continuing operation: In general, it had an increasing trend from 2001 onwards. It has raised its EPS estimate for full year 2009.
  • Dividends per share: On ten year basis an anemic dividend growth. It remained constant between 2001 and 1004.

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.86. This is a medium risk category as per my 3-point risk scale. The slow EPS growth rate and relatively reduced gross margins is making this as medium risk to dividends.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.
  • Dividend growth rate: The average dividend growth of 4.1% (stdev. 3.1%) is less than average EPS growth rate of 11.9% (stdev. 15%).
  • Duration of dividend growth: Dividends have never been cut since 1985. However, they have remained constant between 2001 and 2004.
  • 4 year rolling dividend growth rate for past ten years: Less than 10%.
  • Payout factor: It has been less than 50% since 2004.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 3.04%; and (b) MMA yield is 2.9%. With my projected dividend growth of 4.1%, the dividend cash flow is 1.16 times the MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $29.77 (i.e. yield 4.8%)

Fair Value Calculation
This section determines what price I should pay to buy a given stock
  • Net present value (NPV) price based on 15 year DCF: $35.1
  • Average high yield price calculated based on past 10 years: $43.2
  • Pricing based on past 10 year relative price-to-earnings ratio. $37.6
  • Pricing based on price-to-earnings ratio of 12: $33.0
  • Graham number: $24.5
The range of fair value is calculated as $30.3 to $37.2.

Qualitative Analysis
Kellogg Company was incorporated in 1922. It paid consistently growing dividends from 1985 to 2001. The acquisition of Keebler Foods Co halted this growth and dividends remained flat until 2001. The dividends have started growing back again since 2005 onwards.
  • Its revenue is pretty much focuses in North America which contributes 66% of the revenue. Europe has 20%, Latin America 8%, and Asia Pacific as 6%.
  • It continues to have stable gross and operating margins. It generates relatively stable (albeit not growing) operating and free cash flows.
  • As with any branded consumer staples, Kellogg faces risk from private label products.
  • Kellogg expects to continue increase EPS by the combination of operating cost discipline, share buy backs, and moderate sales based growth.
Conclusion
Kellogg is stable and slow growth company. It is expected to continue to have a good cash flow over next few years. It is not typical dividend growth company where dividends grow in excess of 10%. However, one can expect K to provide stability of dividends in the portfolio. On relative basis to its peers, it is a conservative company with controlled balance sheet which provides room for growth through acquisitions and/or growth of its various brands. The stock’s current risk-to-dividend rating is 1.86 (medium risk). The current pricing of $50.17 is above my buy range. However, I would be open to adding to my existing position when it is near to my buy range and my allocation allows the additions.

Full Disclosure: Long on K.


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