Kellogg Ups the Ante on Brand Spend

After just completing his first year at the helm,

Kellogg's K CEO Steve Cahillane has provided further perspective surrounding the state of the business and the course it's poised to embark upon now that it has closed the chapter on its move away from direct-store distribution. We've long viewed this shift (toward warehouse distribution, which was initially disclosed in February 2017) as a prudent means to extract complexity from its operations while freeing up funds to reinvest in brand-building (as opposed to its distribution network prior), which equates to around 7% of sales, or about $1 billion annually. In our view, these investments should ensure Kellogg is able to weather competitive pressures--resulting from other branded operators, small niche peers (which have proved more agile in responding to evolving consumer trends), and lower-price private-label fare.

And while the crux of management's strategic agenda now seems to center on growing the top line by extending the distribution of its mix and reinvesting in product innovation (including new pack formats) aligned with consumer trends both at home and abroad, we surmise further investments in its manufacturing platform will also be slated for 2019. For one, on-the-go pack sizes have been boasting outsize demand at Kellogg of late, but given the firm presently lacks the supply chain capabilities to meet this heightened demand, this growth has weighed on profits. However, we believe these investments stand to support the intangible assets that underlie its wide moat over a longer horizon.

In this vein, we don't intend to alter our long-term forecast (2%-3% average annual sales growth through fiscal 2027 and 400 basis points of operating margin expansion to around 19% by the end of the decade) and see little change to our $81 fair value estimate. With the shares trading at a 20% discount to our valuation and when combined with its 3%-plus annual dividend yield, we think investors should look to stock up.

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