Description

WK Kellogg is a low-risk consumer staple at an attractive valuation with numerous self-help opportunities unlocked by the recent spin.  

Risk-reward is heavily skewed to the upside for patient shareholders:

The key variable in my 2027 projections is EBITDA margin. Notably, management guides to “mid-teens” EBITDA margin by year-end 2026 largely due to supply chain efficiencies unlocked by capex to refresh the manufacturing base.

I'm betting that:

1. Visibility toward mid teens EBITDA margins emerges by December 2026
2. By that time, the company will be converting nearly 100% of NI into FCF
3. The market will reward the company with a LDD multiple of forward expected FCF by that date, resulting in 100% - 250% total upside over three years

Company background:

• KLG is a pure-play cereal company with ~25% industry share; cereal brands span mainstream and health/wellness categories (e.g. Frosted Flakes, Corn Flakes, Raisin Bran, Special K, Kashi, Bare Naked Granola, and many more). 

• KLG spun out from Kellanova (~$18B diversified packaged food company) in order to increase focus and transform marketing and supply-chain operations

• 88% of sales are in the United States, 11% in Canada, and 1% in the Caribbean

• The company is led by CEO Gary Pilnick, an executive with the parent company since 2000

• ROIC is 22% (tangible capital only)

Favorable industry dynamics and competitive position:

• Oligopolistic market structure – Kellogg, General Mills, and Post control ~75% of the market

• Heavily branded category; this is a good barrier to entry because of accumulated marketing and consumer mind share

• Private label is a threat, but it’s only 7.5% of the market

• Growth is sluggish but positive: expect LSD category growth going forward

• Recession resistant: in weak macro, some consumers trade down to cereal from other more expensive meal options

Recent operational issues and self help opportunities:

• Three big events created inventory outages and loss of grocery shelf space since 2020:

  • COVID factory downtimes

  • Employee strike

  • Factory fire

• Grocers reallocated Kellogg’s shelf space to competitors, and Kellogg estimates that current coverage is 90% of where it should be

• Post-spin pure-play focus on cereal should favor sales team to win back shelf space

• Kellogg also intends to spend $475M in growth capex over three years  to revamp manufacturing operations which will both increase inventory dependability and margins by ~5.0% (hence company guidance “mid teens” EBITDA margins by year-end 2026

• Kellogg also has renewed focus on brand extensions to create consumer excitement and drive sales 

Favorable spin dynamics: 

• CEO Gary Pilnick has aligned incentives, with equity holdings worth multiples of his cash compensation (~$5M in holdings vs. ~$2M in cash comp)

• Management tone on calls is energized; I sense that the team is excited to get to work

• Introduction of 5% annual dividend signals management optimism, and is despite guidance for nearterm negative FCF due to growth capex

• Large parent ($18B K) and small SpinCo ($1B KLG) often results in selling pressure in SpinCo, creating price dislocation

Key risks:

• Cereal category deteriorates due to health and wellness trends. However, KLG is positioned to mitigate this trend with important health and wellness brands (Special K, Bare Naked, Kashi)

• Lack of execution / management can't achieve what they expect to with operational improvements

For a detailed look at my income statement, cash flow, and balance sheet assumptions, see below: 

Catalyst

Management delivers operational improvements, especially EBITDA margin expansion.