Drip Portfolio Report
Thursday, December 18, 1997
by Jeff Fischer (TMFJeff@aol.com)

ALEXANDRIA, VA (Dec. 18, 1997) -- Please note: Tomorrow or Saturday we'll send our $100 for the month to buy more Intel (Nasdaq: INTC). The stock is more than ten dollars below our cost basis and we don't see any long-term changes in the business. Beginning in January, though, we'll begin to invest in Johnson & Johnson (NYSE: JNJ) as well. We'll have more on this and on a slight policy change for the portfolio in tomorrow's column. For now, we expressed our thoughts on Intel yesterday, so we can continue with our search for another stock, beginning with The Oat King:

Quaker Oats (NYSE: OAT)

Description: What Quaker Oats does it generally does well. The company has been the leader in the hot cereal market (with 2/3 of the U.S. market share) for decades, and its Gatorade sports drink has 80% of the world's sports beverage market. What Quaker doesn't do too well it does horribly -- mainly, buy Snapple, lose money on it, and then sell it for a massive $1.4 billion loss this year. The company has a lot going for it, though, and some creative thought behind its initiatives. In the cereal market, for instance -- which is highly price competitive, as we've written here previously -- Quaker introduced cereal in bags rather than boxes, cutting costs and prices.

Major brands include: Life, Cap 'n Crunch, Quaker Oats, Quaker Toasted Oatmeal, Aunt Jemima, Continental (coffee), Rice-A-Roni, Pasta Roni, and Gatorade.

Core Moneymaker: With $5.1 billion in 1996 sales, 82% of those sales were in the U.S. and Canada, and the majority of the money came from the primary products listed above. $1.4 billion in sales was Gatorade alone.

Financials: You should know the drill by now, good Fools.

Because this is an overview, we'll only look at a few key things: how is the company priced relative to sales, earnings per share, and the expected growth rate (valuation); what are the current operating (margins); how much long-term debt does the company have (leverage); and what does management do with the cash that it generates (capital allocation)?

Valuation, Growth, and Share Performance: At $53 per share (a fraction below the 52-week high), Quaker's market cap is $7.3 billion. With trailing sales of $5 billion, the company trades at 1.46 times sales.

The Oat King has $148 million in cash and $891 million in long-term debt. Any acquiring company would consider the cash and debt in its valuation of Quaker, so we subtract the cash and add the debt to the market cap to get a more accurate value for the company -- the enterprise value. The enterprise value of Quaker is closer to $8 billion, and that value in relation to sales is 1.6. This is lower than what we've seen with most of our other food and beverage companies -- a slight plus.

On the earnings per share side, due in part to a massive write-off for the Snapple debacle, the company has negative trailing earnings of $6.88 per share. But the company is expected to earn $1.90 per share in 1997 and $2.23 per share in 1998. The stock trades at 28 and 23 times those estimates, respectively, while analysts expect the company to grow 10% annually the next five years. Quaker's stock has returned 11% annualized the past five years, while the dividend yield is a decent 2.10%.

Margins Reviewed: At Quaker, the operating margin has been under 10% for the past twelve months -- not great, but the company has had the big, bad, and ugly Snapple on its back, so we have to see what it can do when it is free of that and hitting on all cylinders.

The 9.9% operating margins at Quaker compare to Kellogg (NYSE: K) at 16.8%, General Mills (NYSE: GIS) at 15.4%, Campbell Soup (NYSE: CPB) and Anheuser Busch (NYSE: BUD) at 18%, Coca-Cola (NYSE: KO) at 27%, Johnson & Johnson at 22%, and Intel at 41%.

Leverage reviewed: With $891 million in long-term debt and $5 billion in sales, Quaker has a 17.8% debt-to-sales ratio. This is fair. Could be better.

Capital allocation: The company pays a 2.1% dividend, while -- similar to General Mills and Kellogg -- Quaker needs to constantly invest in marketing its brand names, and cereal pricing continues to present challenges. So much so, in fact, that you'll recall that we have initially decided against cold cereal makers Kellogg and General Mills. Quaker is a bit different from those, though, in that it isn't so focused on just cold cereal. It leads without question in hot cereal and with Gatorade, and beverages constitute a significant amount of sales.

As for other capital allocation, in 1993 the company announced a 10 million share buyback program, which it is still doing today. Recently Quaker bought back 441,000 shares for $21 million. Meanwhile, we can expect the company to be gun-shy about acquisitions following the Snapple debacle, and that should be a good thing. Management should now be more careful with money.

The Snapshot for The Oat King:

Ticker: OAT
Recent Price: $53

Trailing 12-month sales: $5.02 billion
Trailing 12-month oper. earnings: $498 million
Operating Margins: 9.9%
Trailing 12-month EPS: N/A

Fiscal '97 EPS estimates: $1.90
Fiscal '98 EPS estimates: $2.23

Enterprise value to sales: 1.6
Current P/E: N/A
P/E on 1997 EPS: 27.8
P/E on 1998 EPS: 23.7
Long-term expected growth rate: 10%
Yield: 2.10%

Conclusion: Much like General Mills and Kellogg, the Quaker brand name is top notch. And the stock price isn't outrageous, though it isn't a screaming bargain, either. What we'd really like to see is how well the company can focus and capitalize on its strengths, obviously the cereals (including the new lower-priced bagged cereals, which could be a hit), the dominant hot cereals, and its Gatorade beverage, now that Snapple is out of the Quaker stable. The sports beverage industry is becoming much more competitive, but Gatorade has held its own.

We'll keep an eye on Quaker -- I like its diversification of hot and cold cereal and its beverages, as well as its lock on the hot cereal market. I'd like to see how it does over the next few quarters and then some, though, as the smoke clears. And the final consideration: growth may not be high enough (at 10% annually) for us to jump in, though earnings are expected to grow 17% next year. With the right management initiatives, the company could probably grow earnings per share more quickly than 10%. It's on our list to watch.

Tomorrow we'll wrap up the week and give some new portfolio information. See you on the message boards. Fool on!


Do your Foolish gift shopping now, in time for the Holidays. And consider the Fool's Industry Focus '98 book -- to learn not only about industry-leading stocks, but about the industries in which they operate as a whole -- and see which one company in each industry that our news and analysis team favors most.

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Stock   Close    Change
INTC  $69  1/8   - 3/8
JNJ   $66 13/16  + 7/16 
            Day        Month      Year      History
Drip        (0.21%)   (5.33%)   (15.40%)    (15.40%)
S&P 500     (1.06%)   (0.01%)    28.97%       0.42% 
Nasdaq      (1.56%)   (4.83%)    17.98%      (4.43%)

Last Rec'd  Total #  Security   In At     Current
12/01/97      6.082       INTC     $81.346   $69.125
11/14/97      1.000       JNJ      $62.125   $66.813

Last Rec'd   Total #  Security  In At    Value   Change
12/01/97      6.082    INTC    $494.72   $420.40  ($74.32)
11/14/97      1.000    JNJ      $62.13    $66.81    $4.69  

Base:   $900.00
Cash:   $389.75**
Total:  $880.84

The Drip Portfolio has been divided into 41.647 shares
with an average purchase price of $24.105 per share. GOAL: The portfolio began with $500 on July 28, 1997, adds $100 on the 15th of every month, and the goal is to grow the port to $150,000 by August of the year 2017.