Kellogg Company’s cash flow increases the security of its dividend yield
Summary of August picks
Based on price performance, the Safest Dividend Yields model portfolio (-4.5%) underperformed the S&P 500 (-2.2%) by 2.3% from August 20, 2021 to September 21, 2021. On Based on total return, the Model Portfolio (-4.0%) underperformed the S&P 500 (-1.9%) by 2.1% over the same period. The top-performing large-cap stock fell 1% and the top-performing small-cap stock rose 2%. Overall, 5 of the 19 Safest Dividend Yield stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from August 20, 2021 to September 21, 2021.
This model portfolio only includes stocks that achieve an attractive or very attractive rating, have positive free cash flow and economic earnings, and offer a dividend yield above 3%. Companies with high free cash flow offer better and safer dividend yields because I know they have the cash to support the dividend. I think this portfolio provides a particularly well-selected group of stocks that can help clients outperform.
Featured Action For September: Kellogg Company
Kellogg Company (K) is the featured stock in September’s Safest Dividend Yield Model Portfolio. Kellogg is a constant profit generator through all economic cycles.
Kellogg has increased its revenue by less than 1% compounded annually and its net operating income after tax (NOPAT) by 1% compounded annually over the past five years. Kellogg’s NOPAT margin remained stable at 10% from 2015 to the rolling twelve month period (TTM), while its return on invested capital (ROIC) also remained stable at 9% during the same period.
The company’s economic profits, or the company’s true cash flow, increased from $ 823 million in 2015 to $ 960 million during the TTM.
Figure 1: Kellogg’s Turnover and economic benefits since 2015
Free cash flow supports dividend payments
Kellogg has paid an annual dividend every year since 1957 and has increased its dividend every year for 16 years. Its dividend in 2020 was $ 2.28 / share, and the current quarterly dividend, when annualized, offers a dividend yield of 3.6%.
As of 2015, Kellogg’s accumulated Free Cash Flow (FCF) easily covers its standard dividend payments. Over the past five years, Kellogg has generated $ 7 billion (31% of current market cap) in FCF while paying out $ 4.5 billion in dividends, according to Figure 2.
Figure 2: Kellogg’s FCF vs. Standard Dividends Since 2015
Companies with a strong FCF offer better quality dividend yields because I know the company has the cash to support its dividend. On the other hand, dividends from companies with a low or negative FCF cannot be as reliable as the company may not be able to continue paying dividends.
K is undervalued
At its current price of $ 64 / share, Kellogg has an economic price-to-book value (PEBV) of 0.5. This ratio means that the market expects Kellogg’s NOPAT to permanently decline by 50%. This expectation seems too pessimistic given that Kellogg has increased NOPAT by 4% compounded annually for the past two decades.
Even though Kellogg’s NOPAT margin drops to 8% (twenty-year low from 10% TTM) and the company’s NOPAT drops 2% compounded annually over the next decade, the stock is worth 99 $ / share today – up 55%. See the math behind this reverse DCF scenario. If the company grows NOPAT more in line with historical growth rates, the stock has even more potential.
Critical details found in financial documents by my company’s Robo-Analyst technology
Below are details of the adjustments I make based on Robo-Analyst’s results in Kellogg’s 10-K and 10-Q:
Income statement: I made $ 554 million in adjustments with a net effect of eliminating $ 162 million in non-operating expenses (1% of revenue). See all adjustments to Kellogg’s income statement here.
Balance sheet: I made adjustments of $ 3.8 billion to calculate the invested capital with a net increase of $ 3.0 billion. The most notable adjustment was $ 1.7 billion (14% of reported net assets) in other comprehensive income. See all of Kellogg’s balance sheet adjustments here.
Valuation: I made $ 10.2 billion in shareholder value adjustments, all of which decrease shareholder value. Besides total debt, one of the most notable adjustments in shareholder value was $ 518 million in minority interest. This adjustment represents 2% of Kellogg’s market value. See all Kellogg Rating Adjustments here.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation for writing about a specific action, style, or theme.