Kellogg (NYSE:K) is a favorite among breakfast-eaters everywhere, with its cereals and other food products being an essential part of the diets of people around the world. Yet, while Kellogg stock has soared in response to the recognition of the industry's importance in producing dependable and consistent earnings for investors, the extent of the stock's rise to all-time highs isn't entirely justified by Kellogg's fundamentals. Let's take a closer look at Kellogg and what's been behind its big rise lately.
Where Kellogg has found growth
The food industry is generally seen as being quiet and defensive, with opportunities for solid dividend income, but not substantial growth prospects. Kellogg has a long history of steady dividend payments to shareholders, with annual payout increases every year since 2005.
But Kellogg, in particular, took advantage of a huge growth opportunity, by making the most of a potential competitor's missteps. Early last year, Kellogg was able to swoop in and buy the Pringles potato chip brand from Procter & Gamble after snack company Diamond Foods (UNKNOWN:DMND.DL) failed to follow through on its initial bid for the P&G division amid a controversy about Diamond's accounting practices. Although margins from Pringles initially proved to be somewhat lower than the company's average, Kellogg has seen substantial organic growth from the division, boding well for its ability to apply pricing pressure to boost margins in the future.
Moreover, Kellogg has sought to get in on emerging markets as a growth driver. Last September, the company entered into a joint venture with Wilmar International to distribute its products in China. With its snack-food market estimated at $12 billion, and showing rapid increases in growth, China represents a golden opportunity for Kellogg.
Kellogg and the Buffett effect
Kellogg stock has been rising without a substantial break for nearly a year now, but what really accelerated interest in the space was the decision from Berkshire Hathaway to partner with a private-equity firm to buy out food giant Heinz. In classic Warren Buffett fashion, the Heinz acquisition revealed the earnings potential of the food industry, which many investors had given up on as having few prospects.
Since the Heinz buyout, though, Kellogg and many of its peers have seen their stocks rise even further. In particular, rival General Mills got a big bump after the late-February Heinz announcement, as investors speculated about whether it or another food company might be the subject of the next big takeover in the industry. Thus far, further major consolidation hasn't really taken place, but many of the potential growth prospects still remain as bullish factors driving investors' considerations in deciding whether to hang onto their stock.
Challenges for Kellogg
Still, Kellogg will still have to deal with obstacles to its future success. A recall of its Mini-Wheats cereal, due to alleged metal-mesh contamination, raised the specter of quality-control issues for the company, and although a proposed $4 million settlement would be relatively minor, the reputational damage could prove more extensive.
The bigger challenge Kellogg faces is simply getting more people to buy its products. Adults have turned away from cereal and, in response, initiatives like its Breakfast To Go dairy drink seek to cash in on the wish for adults to have more on-the-go alternatives to sit-down breakfast cereal. With its strong brand, Kellogg has the capacity for further growth if it can produce innovative products to meet customers' needs and wishes.
Can Kellogg grow fast enough?
Even though prospects for Kellogg look good, Kellogg stock simply can't sustain its recent upward moves forever. With forward earnings multiples rising into the upper teens despite single-digit growth expectations, Kellogg stock looks primed for at least a short-term pullback at some point.
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Fool contributor Dan Caplinger owns shares of Berkshire Hathaway. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Berkshire Hathaway and Procter & Gamble. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.