Consumer Sectors: Ready to Spend

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Edward Aaron, CFA
RBC Capital Markets
[email protected]
595-1127

Kellogg reported a sizeable Q1 beat. Q1 EPS of $1.09 compare to our estimate of $0.95 and consensus of $0.94 on sales of $3.318 billion (consensus $3.291 billion). Though sales were a touch light of our forecast ($3.327 billion), organic growth of 1.8 percent exceeded our 1.2 percent forecast.

With gross profit in line with our forecast, the beat relative to our estimate came mostly from SG&A ($0.10 benefit), helped by timing of ad spending, and a lower tax rate ($0.05 benefit).

"Upfront" charges were $0.03 in the quarter vs. our $0.04 estimate.

While there were puts and takes, overall trends appear decent. The snack business performed very well, and management confirmed significant operational improvements in the Eggo business.

Management reaffirmed constant currency EPS guidance (+11-13 percent) despite higher anticipated inflation pressures. Kellogg now anticipates +3 to +4 percent fiscal year (FY) '10 cost inflation (previously +3 percent), but expectations of strong productivity gains (4-5 percent of cost of goods sold) enabled management to maintain its 100 basis points gross margin expansion target.

We left estimates largely unchanged, but remain above the Street. Changes in timing of ad spend, buyback assumptions and currency preclude us from passing through much of the Q1 beat. Even so, our FY'10 $3.63 estimate is $0.08 above the high end of guidance and $0.04 above consensus.

Our $62 price target values Kellogg at 15.5 times our calendar year (CY) '11 estimated earnings of $4.01 and 10 times our CY'11 EBITDA estimate of $2.7 billion.

This valuation represents a premium to our sector target multiple of 15 times. In our opinion, a premium multiple is warranted for Kellogg due to its superior competitive positioning and quality brands, its track record of under-earning and solid re-investment in its brands and P&L benefits from recent restructuring.

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Vincent Andrews
Morgan Stanley
212-761-3293
[email protected]

We are maintaining our $3.57 estimate, which now incorporates a $0.02 foreign exchange (F/X) headwind relative to flat F/X guidance at 4Q09 and a $0.05 tax benefit that we expect to be offset by fewer share repurchases relative to previous guidance.

Investors' principal 2010 concern with Kellogg had been its "just" 2-3 percent organic top-line growth guidance as well as a likely back-half loaded year. With 1Q top line strong despite tough comps and a 4Q09 US cereal trade load, we believe those concerns are largely behind us.

Nonetheless, at this point in the year, we continue to model 3% internal net sales growth and 10% internal operating profit growth (both at the high end of management guidance).

Kellogg is one of the most predictable and the highest quality earnings growth companies within our packaged food universe driven by: (1) superior operating fundaments; (2) superior innovation; (3) broad-based market share growth; (4) above-average advertising spending (enhances business model sustainability); and (5) commitment to returning cash to shareholders (i.e., $1.3 billion in repurchase authorization available through 2010).

Management maintained its 2010 guidance that calls for 11-13 percent currency-neutral EPS growth. Management continues to guide to +2-3 percent internal net sales growth and expects 8-10 percent internal operating profit growth.