Streetwise for Sunday May 31, 2009

Streetwise

Lauren Rudd

Sunday, May 31, 2009

Do You Understand Breakfast Cereal

Yes, I know the financial markets have been trying of late. Nonetheless, why do so many of you want to make this investing thing so difficult? Forget about daily stock trading, or buying mutual funds. Forget about receiving “help” from your friendly stock broker, or tips from Uncle Joe.

Instead, opt for investment candidates selected from a universe of companies whose products you know and understand, companies that have both with a track record of positive earnings growth and a future that is aligned with the economy. In doing so, you are likely to outperform the vast majority of mutual funds and indexes during any 3-to-5 year period. That statement is based on about four decades of Wall Street experience.

Understand that the emphasis is on you and what you believe and identify with, not what someone else says. However, also understand that in today’s environment you simply cannot invest and then forget. Keep an eye on your investments; make sure the companies are doing what they said they would do.

So by now you are probably thinking that I should provide you with an example of a potential investment. Great idea and I cannot think of a better example than Kellogg.

To start with, Kellogg has achieved a distinguished level of honesty and ethical behavior, a real treat these days. In fact, Kellogg has been called out in the past as being one of the country’s most ethical corporations.

Furthermore, food is an excellent example of a sector with total inelasticity. That means in general there is no substitute product should food prices rise. You still have to eat. And, while you may cut back on the quantity purchased or switch to a lower priced but comparable item, if you have been an on-going consumer of Kellogg’s products then it is highly probable that you will continue in that vein, despite any price increases.

All of which is a long winded way of saying that while Kellogg is not totally recession proof, it is still well positioned to ride out most any economic storm, while still delivering positive results to shareholders.

When I last discussed the company a year ago, my earnings forecast for 2008 was $3.00 per share and $3.50 for 2009. Kellogg posted 2008 earnings of $2.99 per share. So I was a penny light. Given the economy, that was probably not a bad forecast.

For the first quarter of this year, Kellogg reported net earnings of $321 million, a 2 percent increase from last year's $315 million. Earnings on a per share basis were $0.84, a 4 percent increase when compared to the same period a year ago. Note that the first quarter results included an estimated $0.05 per share impact due to the cost of the recent peanut-related recalls.

Net sales decreased 3 percent to $3.2 billion, while cash flow, defined as cash from operating activities less capital expenditures, was $172 million for the quarter.

As part of its earnings announcement, Kellogg indicated that it plans to increase its up-front charges for cost reduction initiatives from $0.14 per share to $0.22 per share, while still maintaining the previously announced 2009 guidance of 3-4 percent net sales growth and mid single-digit operating profit growth.

The cost savings initiatives should enable Kellogg to reduce its annual costs by $1 billion by the end of 2011. The guidance also includes a cost of approximately $0.06 per share in 2009 from peanut-related recalls.

The intrinsic value of the shares, using a discounted earnings approach with an earnings growth rate of 8.8 percent and a discount rate of 10 percent, is $52 per share. The more conservative free cash flow to the firm model produces an intrinsic value of $74 per share.