1 green flag and 1 red flag to divide Kellogg’s big business

Kellogg (K 2.02%) is a company with an incredible history dating back to 1906. It has grown into a food giant with $ 14 billion in annual revenue and operations spanning the globe. Since 2012, the company has been working on a major corporate overhaul and most recently announced its biggest move to date – a tripartite breakup.

That’s why investors should like the plan – and also why some may question the value of the move.

The green flag

Since buying the snack brand Pringles in 2012, Kellogg has changed its portfolio to focus on growth. This includes disposing of slower-growing brands, such as Keebler, and adding better-positioned businesses, such as the Noodle operation in Africa. The company largely ended the portfolio by resetting just as the coronavirus pandemic struck in 2020, making it difficult to see the benefits of the various strategic moves that have been made.

However, the company achieved 5% combined annual growth, using a two-year basis to smooth out the impact of the pandemic between 2019 and 2021. This is a strong number in the food business. Despite the current cross winds, in particular inflation and the strike and fire in the US grain business, the company’s momentum remained strong in the first quarter of 2022, with organic sales growing by 4.2% on an annual basis.

This power comes largely from the snack business and foreign operations. This helps explain why Kellogg announced plans to spin off the U.S. grain business and its relatively small plant-based food business.

In essence, management wants to show how strong its growth potential is and, hopefully, to see that the rest of the business offers the kind of multipliers that peers get focused on breakfast. To put a number on this, Mondelez (MDLZ 2.64%)who did something similar a few years ago has a price-to-earnings (P / E) ratio of approximately 20 times, while Kellogg’s P / E ratio is about 15.

YLharts MDLZ PE ratio data.

If this transaction increases the value of what is currently called Global Snacking Co., investors can very well benefit from the split.

The red flag

Now, let’s look at the other two companies, now known as North America Cereal Co. and Plant Co. The following year, North America Cereal Co. will work back from the aforementioned strikes and fires that should cause the business to look pretty good compared to the recent past. Meanwhile, Plant Co. works in the hot sector. So the move to break up these businesses seems timely.

But there are problems here, the same. For example, both new companies will have to set up internal systems to operate as stand-alone companies. Things like accounting and human resources are one aspect, but they will also need to have separate sales operations. This is likely to significantly increase costs, limiting profitability and growth potential, as funds for such domestic operations will not be available for capital investment opportunities.

In addition, the two companies will have a much smaller scale on their own than as part of Kellogg. Global Snacking Co. will take most of the revenue with it at approximately $ 11.4 billion in sales, North America Cereal Co will have a sales base of $ 2.4 billion, and Plant Co. will win the meager $ 340 million. These are still significant businesses, but they just won’t have the same impact with customers or suppliers they once had.

In other words, investors need to consider the “synergies” that come with this move, which are likely to be significant. While there’s no way to say how big it is, as Kellogg is still working out the details, this is a topic you’ll want to pay close attention to.

There is another subtle problem with grain operations here. North America Cereal Co. will operate in North America, but Global Snacking Co. will control current foreign cereal operations. There are potential conflicts in this agreement. Meanwhile, Global Snacking Co. will retain the Rice Krispies Treats brand, which is likely to be directly related to the Rice Krispies cereals brand, which may also cause some conflict. It will not be easy to structure this transaction and the details can be of great importance.

Good or bad?

At this point, the future is still short in the air because Kellogg has not released enough details about the tripartite breakup to understand what will happen. However, conservative investors may want to carefully consider the potential negatives here, as shareholders may be burdened with fewer desired businesses as the company seeks to unlock a higher rating for its snack operations.

However, growth-minded investors can enjoy the idea of ​​this collapse precisely for this reason, as shareholders may eventually simply sell what they do not want (North America Cereal Co., for example) and keep it. what they want (Global Snacking Co.). No matter which way you lean, shareholders have both green and red flags to balance right now – and probably until the end of the break-up in 2023 or so.

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