Food companies generally offer steady growth over time, but their returns have far exceeded the global benchmark indices over the last couple of years. For instance, Kellogg Company (NYSE:K)’s shares have risen by nearly 35% over the last year. But its forward P/E equates to 15x, which is why the Street is questioning the sustainability of its rally.
A strategic acquisition
To begin with, Kellogg Company (NYSE:K) has a rather high debt/equity ratio of 272%, as compared to General Mills, Inc. (NYSE:GIS)’ 115%. Its high debt levels can be attributed to its acquisition of Pringles for $2.695 billion, which was carried out last year. Since the acquisition, Kellogg Company (NYSE:K) has witnessed a two-fold increase in its snack revenues, while its overall operating cash flows have risen by 11% over the period.
Meanwhile, General Mills, Inc. (NYSE:GIS) sports a lower debt/equity ratio despite going on an acquisition spree last year. This is because General Mills, Inc. (NYSE:GIS) had acquired small companies with concentrated geographical footprint, having little or no competition. Hence General Mills, Inc. (NYSE:GIS) didn’t have to pay as much as Kellogg Company (NYSE:K) for its acquisitions.
Even ConAgra Foods, Inc. (NYSE:CAG) has a high debt/equity ratio of 210%. The processed food company had acquired Ralcorp Holdings for $5 billion last year, which managed to push up its revenues by 16.26% over the last year. But its TTM net income has plunged by 52.02% due to high acquisition related costs. As these costs subside, analysts estimate its annual EPS to grow by 15.81% over the next year.
But this doesn’t imply that Kellogg Company (NYSE:K) made a bad move. Pringles is present in over 150 countries and posted $1.5 billion under FY12 revenues. Since Pringles is geographically more diversified, its acquisition has allowed General Mills, Inc. (NYSE:GIS) to enter new markets without regulatory loops.
To meet its acquisition-related liabilities, Kellogg Company (NYSE:K) had suspended its share repurchases for two years, but continued its dividends payouts. This allowed the company to divert its cash flows to repay its debt, without straining its cash reserves. As of now, Kellogg has a total long-term debt of $7.55 billion.
For the recent quarter, Kellogg posted an overall sales growth of 12% YoY, which was mainly driven by a 7% sales growth (YoY) in its Pringles brand. But Kellogg’s quarterly operating profit declined by 3.5% YoY due to acquisition-related costs. But these costs are expected to subside in the coming quarters, which would naturally bolster Kellogg’s profit margins.