Investors Turn Frosty on Kellogg

Investors in Kellogg showed concern on Monday as the 117-year-old breakfast company implemented a new structure that separated its core North American cereal business from its snack brands, including Pringles.

Stock in WK Kellogg (ticker: KLG), the home of beloved cereals such as Frosted Flakes and Froot Loops, experienced a decline of 9.1%, ending the trading session at $13.35. Kellanova (K), the new name for the snack business formerly known as Kellogg Co., also experienced a drop of nearly 6% to $52.50.

Last month, an approved spinoff plan granted investors one share of WK Kellogg for every four shares of Kellogg Co. they owned. This strategic move aims to prevent competition between the cereal and snack brands for resources. Additionally, it allows WK Kellogg to optimize its supply chain by investing in its most efficient and cost-effective plants. Notably, both companies will continue to utilize the Kellogg branding for their respective products.

Although Kellanova's shares are currently valued at 15.3 times the per-share earnings expected for the upcoming year, while the S&P 500 sells at approximately 17.9 times, investors remain cautious.

Concerns about Kellanova's leverage ratio have been raised by credit analysts at S&P Global Ratings. They expressed a "negative outlook" regarding the debt issued by the company. Kellanova's leverage, which stands at roughly three times adjusted profit, remains consistent with previous quarters after the spinoff. However, the company encounters growth risks due to its less diverse portfolio and changing consumer preferences away from packaged foods, as highlighted by S&P's Arpi Gupta in a statement last month.

A Look at WK Kellogg's Leverage Ratio and Future Outlook

A company's leverage ratio plays a crucial role in determining its financial health. A lower ratio indicates that the company is better equipped to handle its debt, while a higher ratio suggests increased financial risk. In the case of WK Kellogg, if their leverage ratio goes above three times, it could lead to a downgrade of their ratings within the next two years, according to Gupta and the S&P team.

WK Kellogg faces a significant challenge due to the long-term decline of cereal as a category within packaged foods. Analyst Nik Modi from RBC Capital Markets highlights that retail sales volume for cold cereal products has experienced a compound annual decline of 2.4% from 2019 to 2022. This trend poses a problem that may not be resolved by the company's spinoff.

Prior to the deal, Kellogg projected an increase in WK Kellogg's earnings by 2026. They anticipated a five percentage-point gain in margins based on adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) through steps taken to modernize the supply chain. However, net sales are expected to remain stable during this period.

When asked about the sales outlook beyond 2026, WK Kellogg's CEO, Gary Pilnik, emphasized their current focus on the immediate horizon. However, he also acknowledged that future sales growth could come from expanding beyond cereal and leveraging the strength of their brand portfolio.

Despite these challenges, there are still opportunities for growth. Analyst Nik Modi suggests that WK Kellogg's snack business could expand through mergers and acquisitions in the future. Additionally, WK Kellogg is forecasting a healthy dividend payout ratio of 45% by 2024.

However, investors seem to be primarily concerned with the potential downside for now.