Kellogg (K 0.65%) is a company with an incredible history dating all the way back to 1906. It has grown into a food giant with $14 billion in annual revenue and operations spanning the globe. Since 2012 the company has been working on a major corporate overhaul and just recently announced its biggest move yet, a three-way breakup.
Here's why investors should like the plan -- and also why some might question the value of this move.
The green flag
Since buying the Pringles snacking brand in 2012, Kellogg has been reshaping its portfolio to focus on growth. That's involved jettisoning slower growth brands, such as Keebler, and adding better-positioned businesses, like a noodle operation in Africa. The company largely completed the portfolio rejiggering just as the coronavirus pandemic hit in 2020, making it hard to see the benefits of the various strategic moves that had been made.
However, the company achieved 5% compound annual growth, using a two-year basis to smooth out the impact of the pandemic between 2019 and 2021. That's a strong number in the food-making business. Despite current headwinds, notably inflation and a strike and fire in the U.S. cereal business, the company's momentum remained strong in the first quarter of 2022, with year-over-year organic sales up 4.2%.
That strength is largely coming from the snacking business and foreign operations. This helps explain why Kellogg has announced plans to spin off the U.S. cereal business and its relatively small plant-based food operation into stand-alone companies.
Essentially, management wants to showcase just how strong its growth opportunity is and, hopefully, see the remaining business afforded the type of multiple that snack-focused peers are getting. To put a number on that, Mondelez (MDLZ -0.34%), which did something similar several years ago, has a price-to-earnings (P/E) ratio of roughly 20 times while Kellogg's P/E ratio is stuck around 15.
If this transaction boosts the value of what is, for now, being called Global Snacking Co., investors may very well end up benefiting nicely from the split.
The red flag
Now, let's look at the other two companies, now known as North America Cereal Co. and Plant Co. Over the next year or so, North America Cereal Co. will be working back from the above-mentioned strike and fire, which should make the business look pretty good relative to the recent past. Plant Co., meanwhile, operates in a hot sector. So the move to break these businesses out seems timely.
But there are issues here, just the same. For example, both new companies will have to create internal systems to operate as stand-alone businesses. Things like accounting and human resources are one aspect, but they will also need to have stand-alone selling operations. This is likely to increase costs in a big way, limiting profitability and the opportunity for growth since funds for such internal operations won't be available for capital investment opportunities.
Moreover, the two companies will have much less scale alone than they would as part of Kellogg. Global Snacking Co. will take the majority of revenue with it at roughly $11.4 billion in sales, North America Cereal Co will sport a sales base of $2.4 billion, and Plant Co. will earn a scant $340 million. These are still sizable businesses, but they simply won't have the same clout with customers or suppliers that they once had.
In other words, investors need to consider the "dis-synergies" that come with this move, which are likely to be sizable. Although there's no way to tell just how sizable because Kellogg is still working out the details, this is one topic you'll want to pay very close attention to ahead.
There's another subtle issue here, as well, with the cereal operations. North America Cereal Co. will operate in North America, but Global Snacking Co. will control the current foreign cereal operations. There are potential conflicts in this arrangement. Meanwhile, Global Snacking Co. is going to keep the Rice Krispies Treats brand, which is arguably tied directly to the Rice Krispies cereal brand, which could also cause some conflict. It is not going to be simple to structure this deal, and the details may end up mattering a great deal.
Good or bad?
At this point, the future is still a bit up in the air because Kellogg hasn't released enough details about the three-way breakup to really get a handle on what's going to happen. However, conservative investors might want to think carefully about the potential negatives here as shareholders could get saddled with less-than-desirable businesses as the company looks to unlock a higher valuation for its snack operations.
That said, growth-minded investors might relish the idea of this breakup for that very reason, since shareholders can, in the end, just sell what they don't want (North America Cereal Co., for example) and keep what they do want (Global Snacking Co.). No matter which way you lean, shareholders have both green and red flags to balance right now -- and likely all the way up until the breakup is completed in 2023 or so.