On June 21, Kellogg (K 0.74%) announced that it would spin off its plant-based meat operation, MorningStar Farms. It's referring to that future company by the placeholder name of "Plant Co" for now, but whatever name it eventually goes public under, it will be a formidable competitor to Beyond Meat (BYND 8.93%) and privately held Impossible Foods.
Kellogg likely won't complete that spinoff until late 2023 -- and it expects to precede that by spinning off its North American cereal business. However, I believe investors should still get to know this plant-based food company now.
Kellogg's MorningStar Farms is bigger than you think
The idea that MorningStar Farms would be a strong company on its own isn't new. In 2019, journalist Brett Arends published an opinion piece for MarketWatch in which he called the brand "a 'fake meat' gold mine." In it, Arends said that Kellogg could unlock substantial shareholder value by spinning the MorningStar Farms division out, based on the extreme valuation of Beyond Meat stock at the time.
I, too, was once a Kellogg shareholder, attracted to its stable, high-yielding dividend and the impressive growth prospects of MorningStar Farms. According to Vantage Market Research, the plant-based food market is expected to grow at nearly a 12% compound annual rate through 2028 to $79 billion. Therefore, this seems to be a secular growth trend that investors should pay attention to.
Much of the growth in the sales of plant-based meat is being fueled by people who also eat animal-based meat. According to the researchers at Statista, only 2% of the U.S. population identifies as vegan -- a figure that has been virtually unchanged for decades -- while 5% say they are vegetarian. However, people who haven't opted for restrictive diets are increasingly choosing to occasionally forego animal-protein burgers in favor of plant-based ones. And these occasional purchases from a group that comprises the vast majority of the population are fueling outsized growth in the plant-based food industry.
According to Kellogg's presentation, MorningStar Farms generated $340 million in net sales in 2021, up roughly 37% from 2017. By comparison, Kellogg's overall net sales grew by just 10% over this same time period. Therefore, MorningStar Farms is certainly the growthiest part of the company.
Beyond Meat is the perceived leader in the plant-based meat space. But it's not that much bigger than MorningStar Farms. Beyond Meat generated net revenues of $465 million in 2021, just 37% more than MorningStar Farm's $340 million. Impossible Foods doesn't report quarterly financial results, but it's reportedly generating "hundreds of millions" in annual sales as well.
Why MorningStar Farms is in a competitive position
The big difference between MorningStar Farms and Beyond Meat is profitability. In Kellogg's presentation regarding its spinoff plans, it said that MorningStar Farms had $50 million in adjusted earnings before interest, taxes, depreciation, and amortization (EBTIDA) in 2021. By contrast, Beyond Meat had an adjusted EBITDA loss of $113 million in 2021.
Put another way, Beyond Meat generated $125 million more than MorningStar Farms in sales. But MorningStar Farms did $163 million better than Beyond Meat on the bottom line.
Beyond Meat's ultimate goal is to achieve price parity with animal-based protein. And founder and CEO Ethan Brown recently renewed his pledge to achieve price parity within the next two years. Just imagine how consumer preferences might change if plant-based meat was the same price as animal-based meat to buy -- or cheaper. Demand could skyrocket.
However, Beyond Meat doesn't want to sacrifice its gross-profit margin to get to price parity. Management has committed to a gross margin above 30%, although it should be noted that it has been below this for about two years.
For Beyond Meat to achieve a 30% gross margin and get to price parity, its material and manufacturing costs will have to come down substantially. Cutting those expenses is easier with higher sales volume. However, its volume of products sold was only up 12% year over year in the first quarter.
Beyond Meat's volume growth rate may not be enough to provide it with a cost-structure advantage and allow it to achieve price parity within Brown's time period while simultaneously achieving a gross margin of 30%. The alternative would be to drop prices to achieve price parity at the expense of profits. But considering its $113 adjusted EBITDA loss in 2021 and its $79 million adjusted EBITDA loss in Q1 alone, Beyond Meat may not have that luxury.
By contrast, MorningStar Farms is already profitable. And once it's spun out from Kellogg, its management team will be solely focused on growing the brand. This could mean following of strategy of trimming prices to put it at parity with animal-based meat before competitors like Beyond Meat are able to. Considering its superior margins, it may find that option more feasible.
And if MorningStar Farms gets to price parity first, it could enjoy a rising tide of consumer demand. The brand is certainly in an interesting position of strength, which is why I'll be watching the stock closely when it finally comes public as a standalone company next year.