Michigan-based packaged foods giant Kellogg (K) announced on June 21 that it was splitting its business into three independent public companies. The move is intended to generate increased shareholder returns. 

Most of Kellogg’s sales, approximately 80%, will be held within its high-growth, global snacking business. This includes brands such as Pringles, Cheez-It, Pop-Tarts, Eggo, and many others. The other two public companies will be its North American cereal and plant-based foods businesses. Together, they generated $2.74 billion in 2021 revenue.     

There is no question that Kellogg CEO Steve Cahillane and the board want to extract as much value as possible from its snacks business. Hiving off the other two helps accelerate the process. 

So, who will be the next consumer staples large-cap to break itself into several pieces? I’ve got a couple of ideas.

A Business as Big or Bigger Than Kellogg

In the trailing 12 months ended April 2, 2022, Kellogg’s revenue was $14.3 billion, its earnings before interest, taxes, depreciation, and amortization (EBITDA) was $2.55 billion, its market cap is $23.3 billion, and its enterprise value is $31.5 billion.

One of the names that immediately comes to mind is PepsiCo (PEP).

PepsiCo is currently divided into seven reportable segments. In Q1 2022, its Frito-Lay North America snack business had revenue of $4.84 billion, 14.2% higher than Q1 2021, with an operating margin of 26.8%. 

PepsiCo’s second-largest segment by revenue is PepsiCo Beverages North America, with $5.35 billion in sales in the first quarter and an operating margin of 64.2%. However, before you get all excited, the operating profit in the first quarter included $3.02 billion from its sale of Tropicana Juice. Excluding the gain, the North American beverage business had an operating margin of 8.4% or about one-third of the snack business. 

There is no question that Frito-Lay drives the PepsiCo bus.

So, were you to separate PepsiCo into four businesses: Frito-Lay North America, PepsiCo Beverages North America, Quaker Oats, and Rest of the World, based on its 2021 results, the companies would have annual revenues of $19.6 billion, $25.3 billion, $2.8 billion, and $31.8 billion.

A big issue holding a separation back is that the Rest of the World is both beverages and food. How would you separate the two? 

There’s an argument to be made that you keep the food and beverages together outside North America and then sell off Quaker Oats because, in much the same way, Kellogg might have to sell MorningStar Farms -- its plant-based business -- because its sales are pretty low relative to the rest of the company, Quaker Oats sticks out like a sore thumb at PepsiCo headquarters. 

The alternative is to integrate the division into Frito-Lay North America. That’s possible but unlikely. Like Tropicana, it could get a reasonable price for Quaker Oats was it up for sale.

PepsiCo currently has a market cap of $222.2 billion or 2.7x revenue. Frito-Lay North America operating as an independent company, could be valued much higher than this multiple. Let’s say 7x sales. That would value the business at $140 billion or 63% of its current market cap. 

That’s a separation worth considering.

The Second Possible Separation 

At first, I thought about making Procter & Gamble (PG) my second choice, but in the end, I went with General Mills (GIS) instead. In many ways, Kellogg and General Mills are very similar businesses. However, the company’s pet business makes General Mills a more interesting separation.       

In the latest quarter ended Feb. 27, 2022, General Mills’ revenue and operating profit were $4.54 billion and $652.3 million, respectively. Its North America Retail segment accounted for 62% of sales and 77% of operating profits. 

Its Pet segment had $567.7 million in sales (13% overall), $110.6 million in operating profits (14%), and an operating margin approaching 20%. The pet segment’s sales grew 30% year-over-year. 

How much would strategic buyers be willing to pay for 30% YOY growth and a well-known brand such as Blue Buffalo? In April 2018, General Mills paid $8 billion for Blue Buffalo, including the assumption of $400 million in debt. So, based on $1.28 billion in sales at the time, General Mills paid 6.3x sales.

In the last 12 months ended February, its Pet sales (Blue Buffalo) were $2.09 billion. That’s $13.2 billion based on the multiple it paid. I suspect the multiple will be slightly higher today. Let’s say 8x sales or $16.7 billion. 

If the Pet business is worth almost $17 billion, based on an enterprise value of $52.5 billion, the rest of the company’s sales (87% overall) are valued at 2.1x sales. Its North America Retail business could do better as a separately traded company. 

Of the two consumer staples stocks discussed -- PepsiCo and General Mills -- I would argue that the latter is the more likely to do a spinoff in the future.

However, if not these two, more will follow Kellogg’s path in the months ahead.

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