NEW YORK โ Equity research firm TD Cowen, a division of TD Securities, has initiated coverage of WK Kellogg Co as โmarket perform,โ noting that while the companyโs spin-off from Kellanova gives it the opportunity to regain market share in breakfast cereal there is still concern that years of underinvestment โmay have impaired the companyโs brands and hampered its ability to engineer a turnaround in a declining category.โ
TD Cowenโs โmarket performโ rating means the newly formed companyโs stock is expected to have a total return that falls between the parameters of an โoutperformโ (i.e., a stock expected to achieve a total positive return of at least 15% over the next 12 months) and an โunderperformโ (i.e., a stock expected to achieve a total negative return of at least 10% over the next 12 months).
In the report, TD Cowen identified several factors driving its โmarket performโ rating.
First, the research firm said the US cereal category is in โstructural decline.โ
โManagement themselves acknowledge that US breakfast cereal is a structurally declining category,โ TD Cowen said. โOur tracking data indicates a -2.7% CAGR for category volume over the past four years despite structural benefits to food-at-home from the pandemic. The shift in consumer preferences to higher protein, less sugary breakfast foods has played a significant role in these trends. Category growth has decelerated to 1.6% over the past four weeks with volume down 5.6% and will likely worsen in 2024.โ
Along with a declining US cereal category, TD Cowen mentioned that WK Kelloggโs market share has been declining for several years. And while WK Kellogg management believes it can get market share back to where it was before a fire and labor strike at its manufacturing facilities in 2021, TD Cowen analysts are not as optimistic.
โWe note that the companyโs market share had been slipping for several years before the fire/strike occurred and probably would have ended up where it is today (29% compared to 32% in 2019) even if the manufacturing disruption had not occurred,โ TD Cowen said. โManagement describes its top brands as โThe Big Six,โ but none of them have the market power of the must-have brands of their competitors (Cheerios and Honey Bunches of Oats). The companyโs adult-oriented Special K and Kashi brands in particular have failed to adapt to changing consumer preferences.โ
A third reason for caution identified by TD Cowen relates to EBITDA margins. WK Kellogg has set a mid-teens EBITDA margin goal by 2026, a goal that is in line with other competitors in the food category. But according to TD Cowen, the goal represents nearly 600 basis points of expansion from the companyโs starting point in 2023.
โThis sounds hard to do in a category where volume is sharply declining and competitors probably need to discount their prices more aggressively to stabilize it,โ TD Cowen said. โIf so, then Kellogg will need to follow and push back its margin targets.โ
TD Cowen has established an $11 share price target for WK Kellogg based on EV/EBITDA multiple of 6.5x against its forward 12-month EBITDA estimate. The research firm said the best-case scenario includes โhigher-than-expected market share gains in cereal and/or better-than-expected category performance vs. company estimates of down (low single digits)โ as well as โfaster-than-expected margin recovery and improved velocity from consolidated sales force.โ The downside scenario, meanwhile, could feature an โincreased promotional environment leading to price rollbacks on key brandsโ and โhigher-than-expected costs from the spin-off resulting in depressed margins.โ