Kellanova (NYSE: K), which is the global snacking arm of the former Kellogg business, is a leading packaged food manufacturer across many on-trend categories.

The stock is languishing in the face of worries about a falloff in consumer spending that we think are short-sighted. We expect this more-focused company will be able to unlock profitable growth.

Kellanova is one of Morningstar chief U.S. market strategist Dave Sekera’s five undervalued stocks to buy for a higher-for-longer interest-rate environment. It’s also on our latest list of seven undervalued consumer defensive stocks.

After splitting from the North American cereal operations, Kellanova is now focused almost exclusively on its global snack portfolio. But even with the attractive category and geographic exposure the remaining business boasts, it faces headwinds, including cost pressures stemming from raw materials, labor, packaging, and logistics.
We’re encouraged that Kellanova doesn’t intend to tap the brakes on investments in innovation, brand-building, and capacity.

We see these investments as supportive of its brand standing and its entrenched retail relationships long term. Despite concerns about global consumers’ financial health, we think Kellanova benefits from its diverse geographic footprint and will see faster sales growth from its emerging markets.

Key Morningstar metrics for Kellanova

  • Fair Value Estimate: $75
  • Star Rating: 5 Stars
  • Economic Moat Rating: Narrow
  • Uncertainty Rating: Medium

Economic moat rating

An economic moat or sustainable competitive advantage allows a company to earn returns higher than the cost of capital. There are five sources of moat identified by Morningstar analysts and include cost advantage, intangible assets, network effects, switching costs and efficient scale.

We think Kellanova has a narrow moat based on its intangible assets and cost advantage. Its position as a leading packaged food manufacturer in on-trend categories, as well as its resources, has given the company the ability to maintain valuable shelf space and market share.

We expect this competitive advantage should result in excess economic profits, with returns on invested capital (including goodwill) averaging in the midteens over our 10-year explicit forecast, exceeding our 7% weighted average cost of capital. However, competition from other leading global operators and smaller niche startups shows no signs of abating.

When considered with the dearth of switching costs in the food space and Kellanova’s brand concentration (its top five brands account for around 50% of its sales base), we lack confidence that the company’s advantages can hold for the 20 years necessary to warrant a wide moat rating.

Fair value estimate for Kellanova

Our $75 fair value estimate implies a fiscal 2024 enterprise value/EBITDA (earnings before interest, taxes, depreciation and amortisation) of 14 times. Management envisions 3%-5% top-line growth each year against 5%-7% operating profit growth, aims that strike us as achievable.

We think Kellanova is poised to chalk up mid-single-digit growth from faster-growing emerging markets longer term. We believe gross margin will eventually trend back toward 33% by fiscal 2027, generally in line with the average over the past five years, while operating margin will gradually return to the midteens as the company extracts inefficiencies to offset added back-office costs after the split.

Risk and uncertainty

Risk and uncertainty refers to the underlying business and financial risks associated with a company. We recommend a higher margin of safety for companies that face a higher degree of inherent risk. Morningstar analysts rate each company under their coverage as Low, Medium, High, Very high and Extreme.

Kellanova has a medium Risk and Uncertainty Rating. The company is exposed to fluctuating raw material costs, which may eat into profits from time to time. As the company raises prices to offset these pressures, volume may contract if consumers balk.

With around 50% of sales generated outside the United States, Kellanova is also exposed to foreign-exchange fluctuations. This is compounded by the fact that varying tastes and preferences have proved challenging for developed-market packaged food companies looking to expand outside of the US.

We think Kellanova could pursue acquisitions as a means of gaining a greater understanding of local consumer tastes and routes to market, but a deal may prove less beneficial if the company is forced to pay an excessive premium or stumbles in the integration.

Kellanova bulls say

  • Kellanova’s European arm has shown it can win in an intensely competitive market, where private label has pronounced share and retail consolidation has run rampant. This is evidenced by the segment’s 23 consecutive quarters of organic sales growth.
  • We think Pringles has aided Kellanova’s pursuit to build out its global distribution, given the broad appeal of snacks with consumers around the world.
  • The company has amassed an industry-leading presence in faster-growing emerging markets, which should bolster its top-line prospects.

Kellanova bears say

  • Kellanova has strained to keep up with the rapid evolution of consumer trends, which has weighed on volume growth.
  • Cost-reduction efforts may not always prove beneficial. Kellanova’s predecessor sought to remove costs about a decade ago but failed to simultaneously invest in manufacturing and distribution to support growth, resulting in recalls as quality control declined.
  • Despite the increased focus that management claims the split with the domestic cereal business affords, we fail to see how this action enhances the competitive position of the business.