Complaining about the cost of a box of cereal these days? You should see the prices of the stocks of the cereal makers.
Kellogg Co., proprietor of Frosted Flakes, Rice Krispies and Froot Loops, is trading at a neat 18 times its forward earnings, according to S&P Capital IQ. General Mills, whose Cheerios franchise is tops in North America, is closer to 19. And the much smaller Post Holdings, hoping to turn from a loss to a profit in the next year, trades at a price-earnings ratio of 54. (The Canadian subsidiaries are members of the Breakfast Cereal Manufacturers of Canada, along with PepsiCo-owned Quaker Oats Co.)
Investors who see these multiples likely expect the companies behind the stocks to be at least consistently growing sales and profits. The truth, though, is that cold breakfast cereal has been in trouble for some time, and the companies are continuing to report weakness in their core franchises. Efforts to diversify the product lineup have met with mixed results, and their cost-reduction campaigns have sometimes done more harm than good.
The best hope for cereal investors may be that the cereal makers benefit from the current deal-making spree in consumer products, where shrewd operators such as Brazil's 3G Capital buy up iconic brands and then wring out legacy costs from the companies. The enthusiasm for this thesis has driven up P/Es across the sector – the median P/E for the 38 packaged-foods companies on major North American exchanges is 21, per Capital IQ – which means Kellogg and General Mills are cheap, versus their peers. A close look at their results will tell you why.
First, though, what's the matter with cereal? It's probable you need only reflect on your mornings this week to figure it out. A bowl of cold cereal used to be viewed as a convenient breakfast, at least in comparison with eggs, bacon and whatever else dirtied up a handful of pans on the stove. But you can't – or at least shouldn't – eat Corn Flakes on your morning commute, unlike granola bars, breakfast sandwiches or a host of other hand-held or portable options. "For a while, breakfast cereal was convenience food," Abigail Carroll, author of Three Squares: The Invention of the American Meal, told Bloomberg BusinessWeek for a recent cover story on Kellogg's troubles. "But convenience is relative."
That Bloomberg cover depicted Tony the Tiger in a gas mask, recoiling from some apparently radioactive Frosted Flakes, with the headline "They're Gr-r-ross! Carbs, sugar and stubbornness are killing Kellogg." That's likely overstated, of course, but it points to another problem with the cereals loved by past generations: They're loaded with sugar, and many flunk the tests of those trying to eat healthier, whether it's avoiding carbohydrates or genetically modified organisms. (Nearly all U.S. corn contains genetically modified organisms – GMOs – so good luck in seeing any GMO-free Corn Flakes any time soon.) As millennials form more households and have children, the trends are expected to intensify.
Kellogg's first-quarter results, while better than some recent figures, still suggest the problem continues. Sales growth in its U.S. Morning Foods segment dropped 2.9 per cent compared with the prior year. General Mills, which completed its third quarter Feb. 22, said its "U.S. retail segment" sales increased by 1 per cent, with cereal sales flat.
Both of the major players can call on other food products to help offset issues with cereal sales, but some have helped more than others. Kellogg bought the Pringles potato-chip business from Procter & Gamble in May, 2012, for $2.7-billion (U.S.). Added to an existing line of savoury snacks including Keebler cookies, Pringles should help make snacks roughly equal in size to traditional breakfast cereal at Kellogg. (Although Pringles is also likely to suffer from any movement away from what are seen as "processed" foods.) Kellogg owns the Kashi brand of health-positioned cereals, but a number of its products aren't organic or GMO-free.
Cereal is a significant but smaller part of the mix at General Mills, which owns baking products such as Betty Crocker, Progresso soups, Green Giant vegetables and a controlling interest in the company that makes Yoplait yogurt. Yogurt sales, General Mills reported, helped drive its small sales increase in its recent quarter. And the company is moving more quickly in the organic realm: It already owned Cascadian Farm and Muir Glen organic products, and agreed to pay $820-million for Annie's Inc. last October.
This makes General Mills' positioning for millennial food trends "better than expected," say the analysts at Goldman Sachs, who upgraded the company to "neutral" from "sell" last month. The company has "better category exposure" with yogurt and wholesome snacks and "better brand equity," as Cheerios, for example, is widely seen as healthier than sugary peers.
Kellogg, by contrast, is one of the "worst positioned" in packaged foods, "not as much because of its categories, but more from its brands." In a study of consumption patterns among millennials, Goldman says, Kellogg's brands "lag the category average by a material margin in both cereal and crackers, suggesting risk of share losses in coming years."
The smaller Post Holdings, too, has diversified, with egg and dairy products one of its main non-cereal lines of business. Unfortunately for the debt-heavy firm, it revealed this week that Avian flu is spreading through its supply chain, including at least one company-owned facility.
The fears of a wholesale shift in consumption patterns in coming generations have broadly soured analysts on the two bigger stocks. As suggested by Goldman, General Mills is slightly more appreciated: According to Bloomberg, four of 20 analysts have "buy" ratings, versus 11 "holds" and five "sells." Of 21 Kellogg analysts, two have "buys," with 11 "holds" and eight "sells."
Kellogg, which seemingly missed the mark with a past cost-cutting project called K-Lean, has now embarked on a new one, called Project K, which promises to cut employees and reinvest the savings in creating innovative new products. But, at best, 2015 is a rebuilding year, with sales and profits expected to come out below 2014 numbers. Some more hopeful analysts see Kellogg returning to sales growth in the future. But if the trends toward natural and organic foods strengthen, Kellogg may prove to be a cereal disappointment.