Kellanova Shares: A Bittersweet Exit for Some, But a Great Treat for Others (NYSE:K)

For most investors holding shares of Kellanova (NYSE:K), August 14 was probably a pretty good day. For some, it can be bittersweet. But that would only happen because those investors might think they’re underpaid their actions. The reason for this string of statements is that the company’s shares rose, closing up 7.8% for the day. This came after the news broke that Mars, maker of products such as M&M’s, Skittles, Snickers, Hubba Bubba gum, 5, Dove and others, had agreed to acquire Kellanova in an all-cash deal with an enterprise value of $35.9 billion.

For those unfamiliar with Kellanova, the company makes some of the most well-known snack brands on the planet. Examples include Cheez-It, Pringles, Parati and more. When I evaluate the picture, it seems to me that investors are getting a fair deal, more or less. It is possible that another offer might come down the pipe. But given where the stock closed on August 14, that seems unlikely. Between now and when the deal closes in the first half of 2025, investors have an additional potential upside of around 4.1%. And for those who want a fairly low-risk return, it might not be such a bad idea to pick up the stock or hold onto it. But when you consider the time between now and then and the other opportunities out there, I think it makes sense to reduce the stock from the “buy” I had. previously assessed to a “sale”.

A hard downgrade to the stomach

Until today, I had Kellanova rated as a “buy.” Given the growth prospects the company has presented, I’ve even gone so far as to call it a “tasty opportunity” that investors should consider. To be perfectly honest with you, a double downgrade from “buy” to “sell”, especially for such a high-quality company, is hard for me to bear. However, there are two things driving this decision. For starters, since I rated it a “buy” in June of this year, the stock is now up 39.4%. That compares favorably with the 0.3% decline seen by the S&P 500 over the same time window. The second is that when I have a company rated even “hold”, I argue that the stock should perform more or less in line with the broader market lines. And given the cap on the upside, should no further trades be completed, I suspect that the stock from this point forward will likely underperform the S&P 500 between now and the trade.

When it comes to the business itself, investors get a great payday. Mars agreed to acquire Kellanova in an all-cash deal valued at $83.50 per share. That represents a 44% premium to the company’s 30-day volume-weighted average price before rumors of a potential deal began circulating. It’s also 33% above the company’s 52-week high before this deal was rumored. In total, we’re looking at an enterprise value of $35.9 billion. And based on my estimates, the equity value here is about $29.1 billion.

Unfortunately, we do not have an investor presentation that outlines the positives and negatives of this transaction. But that’s because Mars is a family business. So it is not necessary to come up with any meaningful analysis. We know that Kellanova has achieved some pretty impressive financial results in recent years. In the chart above, you can see the financial performance for fiscal years 2021-2023. Revenue rose during that time, rising 11.7%, or 5.7% annually, from $11.75 billion to $13.12 billion. The company’s profitability has been quite mixed. And the same goes for cash flows. That said, as I’ve highlighted in my previous work on the business, it has some fantastic growth opportunities in the global snacking market.

When it comes to the current fiscal year, the results might seem disappointing. Revenues for the first half of 2024 totaled $6.39 billion. That’s down 4.5 percent from the $6.69 billion reported a year earlier. However, this was really the result of currency fluctuations. If we take that out of the equation and take out some of the acquisition and divestiture activity last year, we would actually get organic net sales growth from last year to this year of 4.7%. On an organic basis, the company posted growth in three of its four operating regions.

The only exception to this was last year, where revenue fell slightly from $1.22 billion to $1.24 billion. In the AMEA (Asia, Middle East and Africa) operating regions, sales increased 17.5% from $1.48 billion to $1.74 billion. But here the firm was hit by currency fluctuations. All of the top-line growth the company experienced on an organic basis was due to higher prices. Company-wide, the firm benefited from 8.3% higher prices and a change in product mix. Unfortunately, this brought with it a slight decline of 3.6% overall involving volume measured in tonnage.

From a profitability perspective, things have been largely positive. Net income fell year-over-year from $655 million to $611 million. However, operating cash flow fell from $644 million to $740 million. If we adjust for changes in working capital, we get a nice increase from $871 million to $1.07 billion. And finally, 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 grow 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. This is actually an increase from the previous guidance of 3%. Adjusted earnings per share were also revised higher from $3.55 to $3.65 to $3.65 and $3.75. This would imply adjusted net profits of approximately $1.28 billion. If we assume that GAAP earnings will grow at the same rate, then we would expect a reading this year of about $887.8 million. We have no estimates when it comes to other profitability metrics. But like-for-like increases would translate to adjusted operating cash flow of $1.98 billion and EBITDA of $2.21 billion.

With these estimates for 2024, as well as historical results from 2023, we can see how the company’s stock prices are doing in the chart above. On a price-to-earnings basis, the stock is starting to look pretty expensive. And even on a forward basis, the firm’s other trading multiples make it look more or less fairly valued in my book. But, of course, we also have to pay attention to how other similar firms are evaluated. In the table below, we have compared Kellanova with five similar companies. On both a price-to-earnings and operating cash flow basis, three of the five companies ended up being cheaper than our candidate. That number rises to four out of five when using the EV to EBITDA approach.

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To me, this means that investors are not getting any significant premium for their shares. But I am selling the company at a price that is probably close to the upper end of the fair value range. Interestingly, this leaves open an opportunity for another suitor to enter the game. But if we’re talking about publicly traded businesses, that list is pretty small. If we can only find it to snack-oriented companies or companies that have other similarities to Kellanova, it really limits us to The Hershey Company (HSY), Mondelez International, General Mills (GIS) and The Kraft Heinz Company (KHC). Three of these are similar in size, with market caps ranging from $38.5 billion to $41.8 billion. The only one that could easily complete this kind of deal would be Mondelez International. There have been rumors that both she and Hershey are interested in a potential deal. But given that Kellanova stock has a somewhat significant gap between its current price and its purchase price, the market doesn’t see much chance of anything happening here.

Take away

As much as I appreciate Kellanova, and as much as I’ve been bullish on the company in the past, I think the upside going forward is definitely limited. While there is a small chance another party will come along, I don’t think investors would be wise to bet on it. Those who just want a fairly safe return between now and when the deal is completed sometime next year might do themselves a favor by picking up shares. But for those who want market returns, I think there are plenty of other opportunities elsewhere. Because of this, I have decided to downgrade Kellanova to a “sell” to reflect my view that the stock may underperform the broader market going forward.