According to a April 2013 Food Navigator article, US cereal sales have declined by approximately 1% in each of the past 10 years. Changing consumer habits are to blame for this, as people prefer more convenient and healthy breakfast options.
Kellogg (NYSE:K), the US' largest cereal company, isn't doing well; it announced plans to reduce its global workforce by 7% in November 2013. As a result, most investors hesitate to invest in Post Holdings (NYSE:POST), North America's third-largest ready-to-eat, or RTE, cereal manufacturer.
More than a cereal company
Post Holdings has engaged itself in several M&A deals in the past year to diversify away from its core cereal operations. More notably, it completed the acquisition of Michael Foods, the country's largest producer of processed egg products and refrigerated potato products, in June 2014. While Post Holdings used to be a one-trick pony in 2012 when RTE cereal accounted for all of its sales, it has transformed into a diversified multi-product consumer company in 2014. With all of its completed acquisitions reflected on a pro forma basis, RTE cereal will represent only 27% of Post Holdings' revenue.
Instead, Michael Foods' acquired businesses will now account for close to half of Post Holdings' top line. More specifically, Post Holdings will generate approximately 35% of its revenue from egg products. This is particularly significant because of the growth in breakfast foods.
According to research by NPD, breakfast was the only growing daypart in the quick-service restaurant, or QSR, channel during the past five years. In fact, eggs ranked among the top three non-beverage breakfast choices for Americans.
Recent research by the US Department of Agriculture also found that current eggs were healthier, with more Vitamin D and less cholesterol, than eggs tested in 2002 and largely attributed this to improvements in hen feed. Post Holdings should benefit from Michael Foods' market leadership in value-added eggs in the foodservice channel and egg whites in the retail market.
Post Holdings has another source of growth in its new active nutrition business, as it estimates that the business accounts for 13% of its revenue. This came as a result of Post Holdings' acquisitions of Premier Nutrition Corporation and Dymatize Enterprises last year.
Dymatize manufactures premium protein powders, bars, and nutritional supplements, a category which Euromonitor forecast to grow at a 2014-2017 compound annual growth rate, or CAGR, of 7%; Premier Nutrition distributes premium protein beverages and foods. These acquired businesses will allow Post Holdings to capitalize on the growth in demand for sports nutrition, weight loss, meal replacement, and protein-based products.
Post Holdings isn't the only cereal company that has diversified its operations in light of declining cereal sales; Kellogg had been an early mover in that respect. In 2000, cereal products accounted for three-quarters of Kellogg's sales.
After Kellogg acquired Keebler Company, the biggest North American cookie and cracker manufacturer, in 2001 cereal's contribution to Kellogg's top line fell to 55%. By 2013, breakfast foods, including cereal products, represented less than a quarter of its total revenue. Kellogg's purchase of Pringles in 2012 made it the second-largest snacks company globally and was instrumental in furthering its diversification efforts.
Post to post
In a competitive consumer foods market, good management is critical for success and Post Holdings probably has one of the best CEOs in town in William Stiritz. Two factors contribute to investors' positive sentiment toward Stiritz.
Firstly, a May 2014 Reuters article commented that Stiritz 'has built a track record over the past 30 years that ranks among the best on Wall Street.' This is by no means an exaggeration. An investment of $100 made in 1981 in Ralston Purina, an animal feed and pet food company (when Stiritz was named its CEO), would have returned $5,700 if the investor held the investment until 2000. Investors have high hopes that Stiritz will be able to recreate the magic at Post Holdings.
Secondly, Stiritz's interests are aligned with those of Post Holdings. His base salary is only $1 per year, with the rest of his compensation tied to stock options granted at market prices. More importantly, the options have a vesting period of more than three years and Stiritz can only exercise them after he ceases to be a company executive. This ensures that Stiritz will place more emphasis on long-term value creation for Post Holdings than his personal interests.
Foolish final thoughts
Notwithstanding declining cereal sales, Post Holdings is still a good investment candidate because of its transformation into a multi-product consumer enterprise and the leadership of Stiritz. Post Holdings has underperformed the S&P 500 for the past 52 weeks, with its share price rising 8.4% compared with a 19.7% increase in the S&P 500 over the same period. This provides an attractive entry point for potential investors who are interested in Post Holdings.