For most investors owning shares of Kellanova (NYSE:K), August 14th was probably a pretty good day. To some, it may be bittersweet. But that would only be because those particular investors might think that they are being underpaid for their shares. The reason for this string of statements is because shares of the company spiked, closing up 7.8% for the day. This came after news broke that Mars, the producer of products like M&M’s, Skittles, Snickers, Hubba Bubba gum, 5, Dove, and more had agreed to acquire Kellanova in an all-cash deal with an enterprise value of $35.9 billion.
For those not familiar with Kellanova, the company produces some of the most famous snack brands on the planet. Examples include Cheez-It, Pringles, Parati, and more. When evaluating the picture, it seems to me as though investors are getting a fair deal, more or less. It is possible that another offer could come through the pipeline. But given where shares closed at on August 14th, this looks unlikely. Between now and the time that the deal is closed sometime in the first half of 2025, investors have additional upside potential of about 4.1%. And for those who do want a fairly low-risk return, picking up the stock or keeping hold of it might not be such a bad idea. But when you consider the time that will pass between now and then and the other opportunities that are out there, I think that it’s only sensible for me to downgrade the stock from the ‘buy’ I had it rated previously to a ‘sell’.
A tough downgrade to stomach
Up until today, I had Kellanova rated a ‘buy’. Given the growth prospects that the company exhibited, I even went so far as to call it a ‘tasty opportunity’ that investors should consider. To be perfectly honest with you, a double downgrade from a ‘buy’ to a ‘sell’, particularly for such a high-quality company, is difficult for me to stomach. However, there are two things driving this decision. For starters, since I rated it a ‘buy’ back in June of this year, shares are now up a whopping 39.4%. That compares favorably against the 0.3% decline seen by the S&P 500 over the same window of time. The second is that, when I have a company rated even a ‘hold’, it is my claim that the stock should more or less perform along the lines of the broader market. And given the cap on upside should no other deal come through, I suspect that shares from this point on will probably underperform the S&P 500 between now and the time the deal was completed.
When it comes to the deal itself, investors are getting a heck of a payday. Mars agreed to acquire Kellanova in an all-cash transaction valued at $83.50 per share. This represents a 44% premium over the 30-trading day volume weighted average price of the company prior to rumors starting to circulate of a potential deal. It’s also 33% above the firm’s 52-week high point prior to this deal being rumored. In all, we are looking at an enterprise value of $35.9 billion. And based on my estimates, the equity value here is about $29.1 billion.
Author – SEC EDGAR Data
Unfortunately, we don’t have an investor presentation to walk us through the positives and negatives of this deal. But that is because Mars is a family-owned business. So it’s not required to come out with any meaningful analysis. We do know that, over the past few years, Kellanova has achieved some rather impressive financial results. In the chart above, you can see financial performance for the 2021 through 2023 fiscal years. Revenue increased during this time, rising by 11.7%, or 5.7% annually, from $11.75 billion to $13.12 billion. Profitability for the company has been rather mixed. And the same holds true of cash flows. Having said that, as I pointed out in my prior work on the business, it does have some fantastic growth opportunities from the global snack market.
Author – SEC EDGAR Data
When it comes to the current fiscal year, results might seem disappointing. Revenue for the first half of 2024 totaled $6.39 billion. This represents a drop of 4.5% compared to the $6.69 billion reported one year earlier. However, this was really the result of foreign currency fluctuations. If we strip this out of the equation, and we strip out some acquisition and divestiture activity last year, we actually would get an organic net sales increase from last year to this year of 4.7%. On an organic basis, the company achieved growth across three of its four operating regions.
The one exception to this was year up, where revenue dropped slightly from $1.22 billion to $1.24 billion. In the AMEA (Asia, Middle East, and Africa) operating regions, sales popped up a whopping 17.5% from $1.48 billion to $1.74 billion. But this was where the firm was hit with the foreign currency fluctuations. All of the growth the company has seen on the top line on an organic basis has been because of higher pricing. Company-wide, the firm benefited to the tune of 8.3% from higher prices and a shift in product mix. Unfortunately, this did bring with it a slight decline, 3.6% in total, involving volume as measured by tonnage.
From a profitability perspective, things have been mostly positive. Net income did drop year over year from $655 million to $611 million. However, operating cash flow popped from $644 million to $740 million. If we adjust for changes in working capital, we get a nice surge from $871 million to $1.07 billion. And lastly, EBITDA for the company managed to grow from $1.01 billion to just under $1.10 billion.
For the current fiscal year, management expects organic revenue to rise by 3.5%. This guidance was actually issued when the firm announced results for the second quarter of its 2024 fiscal year just a few days ago. That’s actually an increase over the prior guidance of 3%. Adjusted earnings per share have also been revised higher from between $3.55 and $3.65 to between $3.65 and $3.75. This would imply adjusted net profits of about $1.28 billion. If we assume that GAAP earnings will rise at the same rate, then we would expect a reading this year of about $887.8 million. We don’t have estimates when it comes to other profitability metrics. But similar increases would translate to adjusted operating cash flow of $1.98 billion and EBITDA of $2.21 billion.
Author – SEC EDGAR Data
With these estimates for 2024, as well as historical results from 2023, we can see how shares of the company are priced in the chart above. On a price to earnings basis, shares are starting to look quite pricey. And even on a forward basis, the other trading multiples of the firm make it look more or less fairly valued in my book. But of course, we also need to pay attention to how other similar firms are valued. In the table below, I compared Kellanova to five similar enterprises. On both a price to earnings basis and a price to operating cash flow basis, three of the five companies ended up being cheaper than our candidate. This number rises to four of the five when using the EV to EBITDA approach.
| Company | Price / Earnings | Price / Operating Cash Flow | EV / EBITDA |
| Kellanova | 32.8 | 14.7 | 16.3 |
| Tyson Foods (TSN) | 54.9 | 9.5 | 15.3 |
| McCormick & Company (MKC) | 28.4 | 18.4 | 19.9 |
| Hormel Foods (HRL) | 23.0 | 13.8 | 15.0 |
| Conagra Brands (CAG) | 42.4 | 7.4 | 15.9 |
| Mondelez International (MDLZ) | 24.6 | 19.9 | 14.4 |
To me, this means that investors aren’t getting any meaningful premium for their stock. But they are selling the company off at a price that is perhaps near the upper end of the fair value range. Interestingly, this does leave open an opportunity that another suitor could come into play. But if we are talking about publicly traded businesses, that list is quite small. If we can find it only to snack oriented firms or firms that have other similarities to Kellanova, it really does restrict us to The Hershey Company (HSY), Mondelez International, General Mills (GIS), and The Kraft Heinz Company (KHC). Three of these are similarly sized, with market capitalizations ranging between $38.5 billion and $41.8 billion. The only one that could easily complete this kind of transaction would be Mondelez International. There have been rumors that both it and Hershey are interested in a potential transaction. But considering that shares of Kellanova do you have a somewhat meaningful gap between their current price and the buyout price, the market doesn’t see much of a chance of something happening here.
Takeaway
As much as I appreciate Kellanova and as much as I have been bullish on the company in the past, I do think that upside from this point on is certainly limited. While there is some small chance some other party might come through, I don’t think investors would be wise to bank on that. Those who just want a fairly safe return between now and the time the transaction is completed sometime next year might be doing themselves a favor by picking up shares. But for those who want market beating returns, I think that there are plenty of other opportunities elsewhere. Because of this, I’ve decided to downgrade Kellanova to a ‘sell’ to reflect my view that shares are likely to underperform the broader market moving forward.
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