Kellogg (K 1.05%) is in the process of making over its business with an eye on boosting its growth profile. There have been huge changes, with one of the biggest still on the horizon. The game plan, however, has been altered just a little bit. Management now planning to keep its Morningstar Foods brand in-house even as it continues with plans to exit the U.S. cereal business.
Here's why this plant-based meat brand is staying in-house and why that's good for shareholders.
Getting to growth
Not too long ago, consumer staples icon Kellogg was full of old, stodgy brands. Slow growth was basically the best that could be hoped for the company. Investors were downbeat on the business as its competitors increasingly shifted toward more growth-oriented products in the food industry, such as snacks.
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Kellogg decided it needed to catch up and did a little wheeling and dealing of its own, selling off brands like Keebler and buying brands like Pringles. The goal was to shift the product mix toward growth as more successful peers had done. Today, snacks are one of the largest revenue drivers for the company, posting robust growth in every geographic region the company serves.
What the company didn't change was its continued support of its namesake product, cereal. Yet cereal, notably in North America, has been a major drag on results for some time. In early 2022, the company finally decided to make the hard call and split its North American cereal division off as a stand-alone company.
The hope is that exiting this business will lead to a higher valuation for the rest of the company. But while it was doing the legwork for a corporate spinoff, management decided that it would also put in the legwork to spin off its Morningstar Farms brand, which makes plant-based meat products. This is a relatively tiny division, but one worth watching.
Keeping things in-house
Now, Kellogg has had a change of heart. When the company reported full-year 2022 financial results, it said that the cereal breakup was full steam ahead, but that Morningstar Farms was going to remain in-house. Originally the idea was that, given the valuations being placed on companies like Beyond Meat (BYND -0.17%) at the time of the spinoff announcement, a stand-alone Morningstar Farms would be given a high valuation.
The problem is that over the past year or so, Beyond Meat's stock price has tumbled as investors have become less enamored with the plant-based meat story. So Morningstar Farms would likely not get the valuation that Kellogg had hoped for and, thus, setting it up as its own company wouldn't be as beneficial for Kellogg shareholders. But here's where things start to get interesting.
Inside of Kellogg, Morningstar Farms will have far more financial support and business heft than it would on its own. That means stronger relations with retailers, more marketing and distribution support, and more cash available for investing in brand innovation. Smaller food companies usually have a hard time competing with the industry's giants, but that's not going to be a problem for Morningstar Farms because it is going to remain a product line within an industry giant.
Also, according to Kellogg, the Morningstar Farms business is profitable. The same can't be said of Beyond Meat. Moreover, management highlighted Morningstar Farms' strong brand recognition and household penetration. In other words, it is fairly well-positioned in the plant-based meat segment. This segment, meanwhile, is expected to double in size over 2021 levels by 2028, with a compound annual growth rate of 15%. If Morningstar Farms can simply keep pace with the broader sector (it has actually outperformed in many years), its growth rate should be very strong.
To be fair, Morningstar Farms has been struggling a little over the past year. But the biggest problem has been keeping up with demand, which is, as far as headwinds go, a decidedly positive thing. Kellogg has moved to shore up its capacity, which suggests that the division will be on a stronger path in 2023.
Small, but worth watching closely
When Kellogg announced plans to spin Morningstar Farms off in early 2022, the business was estimated to have sales of around $340 million. Compared to the company's $15 billion-plus in total 2022 revenue, Morningstar Farms is just a drop in the bucket even if its sales double by 2028, along with industry growth. It isn't the driving story for the company.
However, plant-based meat alternatives are a real business opportunity and one in which Kellogg has a robust offering. Investors shouldn't get too caught up on Morningstar Farms, per se, but this brand could very quickly become a hidden gem for the food maker as it shifts toward growth.
