Imagine perusing the cereal aisle at your local grocery store and finding empty shelves in place of the most coveted brands of cereal: Frosted Flakes ("They're gone!"); Rice Krispies (snap, crackle, not stocked); and Corn Flakes (the rooster has flown the coop). The power of these brands is a hallmark of a great company and one of the reasons that Kellogg(K 0.28%) deserves a look. Here are four reasons investors should seriously consider Kellogg as a portion of their healthy, balanced portfolio.
1. Upwardly marching earnings
In the world of long-term investing, it is imperative to find companies with an established track record of increasing earnings -- think ski slope. This pattern equates indicates predictability, which leads to a degree of confidence as to how the business will perform in the future. Earnings performance and retention ultimately equates to greater future value as the market recognizes increased book value.
Although Kellogg recently turned in lackluster results in its full-year earnings report with diluted earnings per share down 1.7% to $1.72 and net sales down 7.2% to $13.5 billion, pulling back to see the broader picture reveals that Kellogg has in fact logged a solid record of earnings growth over the past 15 years, albeit with dips in 2012, 2014, and 2015. From 2003 to 2013, earnings per share for the company grew from $1.92 to $4.94, a 9.9% annual growth rate.
2. A stratospheric return on equity
In its simplest form, return on equity (ROE) indicates how much profit is generated by each dollar of shareholder equity or book value. Technically defined as net income divided by shareholders' equity, this metric is not to be confused with the market returns that investors should expect as market value and book value are distinct measures. But over time, markets will recognize the weight of book value and price the company accordingly. Warren Buffett epitomized this concept in a Benjamin Graham quote in his 1987 Berkshire Hathaway letter to shareholders:
In the short run, the market is a voting machine, but in the long run, it is a weighing machine.
Return on equity is a measure of the potential for a company to increase this weight over time and deliver substantial returns to the shareholder. Given that the historic, long-term ROE for American businesses has been 11%, investors should wisely seek out investments with averages well above this mark. Kellogg, for example, has generated a stratospheric return on equity that has averaged 54.7% from 2003 to 2013 and 49.1% over the last five years.
3. A demographic wave of snack population growth
According to data published by Nielsen, the global population spent $374 billion on snack food from 2013 to 2014, equating to approximately $52.22 per person. Based on Kellogg's full-year and fourth quarter earnings report, the company captured approximately 2% of this global spend as snack revenue for the company now represents 50% of the top line.
If the global population grows to a projected 8.6 billion by 2033 and snack spending inflates by 1% per year, then at a 2% market share, Kellogg will realize approximately $11 billion in revenue from its snack business alone.
4. An economic moat of snacks and breakfast cereal
Source: Pringles
An economic moat creates a durable competitive advantage for a company, allowing it to protect its market share and profitability. For Kellogg, this moat is found in the indomitable brands that it has been building over the last 110 years. Although consumers have been changing their breakfast food preferences recently and switching to less carb-driven, healthier alternatives, Kellogg is adjusting and offering up healthier variations of its staples such as Special K Nourish with apples, raspberries, and almonds.
As mentioned previously, a quick acid test for an economic moat is to ask, "If this item was removed from grocery store shelves, would consumers notice?" If household brands like Frosted Flakes, Rice Krispies, Pop-Tarts, Eggo Waffles, Pringles, and Keebler suddenly disappeared from grocery store shelves, shoppers would likely take note.
In Warren Buffett's opinion, investors should seek out businesses that can be purchased and left alone for 10 years with the knowledge that they will be much more valuable at the end of the long-term period. Although the future is not certain, a business with enduring economic advantages provides a tailwind for superior returns.
Given the company's track record of earnings, its favorable wave of demographic growth, and its wide moat, this is a long-term investment worth watching.
