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Kellogg Earnings Analysis: Understatement of Reported Net Income?

Kellogg Earnings Analysis

Yesterday, Kellogg Company (NYSE:K) reported preliminary financial results for the quarter ended 2013-09-30 (full transcript). Stocks in the food processing industry have seen an overall increase of over 35%this year while Kellogg stock has only seen a year-to-date change of over 12%. Kellogg operates as a food manufacturing company. Its brands include Kellogg’s, Keebler, Pop-Tarts, Eggo, Cheez-It, Nutri-Grain, Rice Krispies, Murray, Austin, Morningstar Farms, Famous Amos, Carr’s, Plantation, Ready Crust and Kashi, which are manufactured in 18 countries and marketed in more than 180 countries.

Kellogg Company (NYSE:K)

Our peer-based analysis of Kellogg Company (peer set at the end of the post) looks at the company’s performance over the last twelve months (unless stated otherwise). The table below shows the preliminary results along with the recent trend for revenues, net income and returns.

Quarterly (USD million) 2013-09-30 2013-06-30 2013-03-31 2012-12-31 2012-09-30
Revenues 3,718.0 3,716.0 3,862.0 3,564.0 3,720.0
Revenue Growth % 0.1 (3.8) 8.4 (4.2) 7.1
Net Income 326.0 352.0 311.0 (32.0) 296.0
Net Income Growth % (7.4) 13.2 N/A (110.8) (1.7)
Net Margin % 8.8 9.5 8.1 (0.9) 8.0
ROE % (Annualized) 48.4 52.7 47.8 (5.3) 51.6
ROA % (Annualized) 8.6 9.3 8.2 (0.9) 8.0

Valuation Drivers

Kellogg Company’s current Price/Book of 8.0 is about average in its peer group. Kellogg’s operating performance is higher than the average of its chosen peers (ROE of 36.3% compared to the peer average ROE of 23.8%) but the market does not seem to expect higher growth relative to peers (PE of 23.9 compared to peer average of 23.9) but simply to maintain its relatively high rates of return.

The company’s asset efficiency (asset turns of 1.0x) and net profit margins of 6.4% are both average for its peer group. Kellogg’s net margin is its lowest relative to the last five years and compares to a high of 10.1% in 2010.

Long-term strategic bet

While Kellogg’s revenues growth has been below the peer average in the last few years (4.1% vs. 6.3% respectively for the past three years), the market still gives the stock an about peer average PE ratio of 23.9. The market seems to see the company as a long-term strategic bet.

Kellogg’s annualized rate of change in capital of 13.0% over the past three years is around its peer average of 15.3%. This average investment has likewise generated a peer average return on capital of 14.2% averaged over the same three years. This average return on investment implies that company is investing appropriately.

Kellogg Earnings Quality– Possible Understatement of Net Income?

Kellogg’s net income margin for the last twelve months is around the peer average (6.4% vs. peer average of 6.6%). This average margin and relatively conservative accrual policy (5.5% vs. peer average of 4.2%) suggests possible understatement of its reported net income.

Kellogg’s accruals over the last twelve months are positive suggesting a buildup of reserves. In addition, the level of accrual is greater than the peer average — which suggests a relatively strong buildup in reserves compared to its peers.

Trend Charts for Kellogg Company (NYSE:K)

Kellogg Earnings Analysis (NYSE:K) Quarterly and Annual Revenues Trend Chart

Kellogg Earnings Analysis (NYSE:K) Quarterly and Annual Net Margin Trend Chart

Kellogg Earnings Analysis (NYSE:K) Quarterly and Annual Accruals Trend Chart

Peers used for Kellogg Earnings Analysis

Kellogg Earnings Analysis used the following peer-set: PepsiCo, Inc. (NYSE:PEP), Mondelez International Inc (NASDAQ:MDLZ), General Mills, Inc. (NYSE:GIS), Flowers Foods, Inc. (NYSE:FLO), The Hain Celestial Group, Inc. (NASDAQ:HAIN) and TreeHouse Foods Inc. (NYSE:THS).