Kellogg (K -0.51%) is a food icon, with most people likely to associate the name with cereal. That makes sense, but like most food makers, Kellogg produces a lot more than just one product.
In fact, cereal is now one of the less desirable business lines within the company. That's about to change at what is an interesting time for the cereal business.
Shifting into high gear
The food industry is dominated by large companies that own collections of iconic brands. Kellogg is no different, with brands like Kellogg's (which gets appended to many different cereal names), Pringles, Pop-Tarts, Eggo, and Cheez-It.
But in the food industry, consumer tastes shift and change over time, and the big companies adjust their brand portfolios along with it.
Image source: Getty Images.
In recent years, Kellogg has sold slower-growing brands, like the Keebler cookie business, and bought faster-growing brands like Pringles. Overall, snacking has taken on a larger role at the company.
However, given Kellogg's history, name, and association with breakfast, one product category seemed like it was off-limits: cereal. The problem with cereal is that consumers have been shifting toward other breakfast options, including the faster-growing snack-bar category. Thus, despite history, Kellogg's growth has been dragged down by what was once its main business.
Wall Street tends to frown on situations like this, often clamoring for a spinoff of the laggard business. The pitch is that the slow-growing business can better focus its attention on improving results, while the remaining business will be able to shine because its growth won't be overshadowed by the slower growing spinoff.
Kellogg has succumbed to Wall Street's siren call.
Great timing
The interesting thing about Kellogg's decision is the timing. The company's cereal operation got hit hard by a strike at its North American production facilities and a fire that shut a factory down. So the division's results were absolutely terrible for a spell, including a notable loss of market share. Those problems are in the rearview mirror at this point, so the division's results are showing dramatic improvement.
To put some numbers on this, North American cereal sales fell 10% in the first quarter of 2022. Then they shifted into the positive column, with sales gains of 8% and 12% in the second and third quarters, respectively. The fourth quarter of fiscal 2022, which ended in April 2023, saw sales rocket 43% higher!
That basically represents the anniversary of the hardest times noted above. There could be a couple more quarters with outsize sales gains that will, as it happens, coincide very well with the company's plans to spin off the North American cereal business later in the year.
In other words, Kellogg will spin off its weakest business just when that business is showing unusual strength. It's great for Kellogg, as it should make the spinoff easier to justify and accomplish.
But for investors, the strong near-term performance, which is highly likely to be temporary, might give a false sense of the underlying business fundamentals. Cereal is still a mature and highly competitive food space where growth will be slow, at best, over the long term.
To be fair, a healthy cereal business will probably be a strong cash generator. So the spinoff isn't necessarily a bad thing for investors. Well-managed cash cows can generate strong dividends for a very long time. But it is important for investors to remember that Kellogg's timing is putting the North American cereal operation in a very positive light that is unlikely to be sustainable (43% quarterly sales growth is clearly an outlier).
Weakness ahead
When all is said and done, and shareholders own the growth-focused Kellogg operations (to be called Kellanova) and the North American cereal business (WK Kellogg Co.), they need to make sure they have their expectations set properly. Kellanova should be a faster-growing operation, and WK Kellogg is likely to be a very slow-growing cash cow.
The strong cereal results of late are not an indication of long-term opportunity. Expecting anything more from WK Kellogg will likely leave you sadly disappointed.
