Rebel Income Put Sale of the Week: Kellogg Co (K)

  • K Current Price: $58.36
  • Put Sale: Sell the February Week 3 (expires 2/19) $57.50 Put. 
    • Current Bid: $1.20
  • Yield on committed capital: 2.08%
  • This trade expires in 17 days.

For the stock market, 2021 clearly appears to reflect investor’s desire to move away from the pandemic-dominated conversations of 2020 and look ahead. One of the ways that has been seen over the last few weeks is in a pretty broad rotation away from conservative, defensive-oriented stocks in sectors like Consumer Staples and into more cyclical names. On multiple occasions over the past few months, I’ve heard the word “boring” used to describe those defensive-minded stocks on news media. Despite the bearish pressure being put on a lot of those stocks right now, the “boring” description makes me chuckle. That’s because I still think these are smart stocks to pay attention to.

I’ve been writing for quite some time in this space about the value to be found in defensively-positioned industries. One of those is the Food Products industry, where a lot of established brands we all grew up can be found. Before the pandemic forced people to stay at home and start stocking their pantries and freezers, a lot of these traditional names were out of favor with the market and with the Millennial generation as being tired, old, and out of touch with the times – in other words, “boring.” One of the specific segments of the industry this has been seen in is in cereal consumption, where consumers had been drifting away from packaged cereal products, but saw an increase in demand in 2020 because of the pandemic.

The reason I like stocks in this industry is that when economic conditions get tough enough that people start losing their jobs and seeing income levels drop, a lot of assumptions about what is “cool” and “hip” start to go away. Recent unemployment reports indicate claims remain around 900,000, after mostly trending lower into the end of 2020; but the fact that current claims are still about 50% above the highest levels seen in the last recession more than a decade should make anybody think twice about taking too much risk in the stock market right now. Data reported yesterday from the Federal Reserve also indicates a wide discrepancy in jobless rates based on income levels; the lowest income levels tracked by the Fed are showing unemployment for those workers is around 50% versus about 5% for workers at the highest levels. My take on that information is that the worst isn’t over; in fact a lot of economists are saying that it will take years, not months for employment to increase again to healthy levels. Even more to the point, the Congressional Budget Office is forecasting that employment won’t return to pre-pandemic levels within the next decade.

Consider that, even as vaccines are being approved and distributed, health experts are still forecasting pandemic conditions to persist into the second quarter of 2021, with some pointing to sometime in the second half of the year before any real traction is seen. That means that the long-anticipated “return to normal” may not be seen in tangible terms until late this year – or possibly beyond. That means economic conditions are likely to remain challenged, which means that consumers are going to have to keep thinking in very critical terms about how they’re going to tighten their belts to make it through. That’s why I think a lot of the old, “tired” brands that we always saw in our parent’s fridges, freezers and pantries, and that are still around today look a lot more attractive, because in most cases those brands have always been built around value. Tightening the belt often means these products come back into favor since they make it easier for parents to keep their kids fed.

Kellogg Company (K) is a classic example of what I mean. They do a lot more than just cereal, of course, but the truth is that the cereal aisle is where you recognize them the most quickly. After following the broad market to a bearish low in March 2020 around $54, the stock rebounded to a peak in late July at nearly $73. From that point, the stock has dropped back into a clear downward trend, and as of this writing is only a couple of dollars away from that bear market low point. That sad stock performance belies the fact that K’s balance sheet is healthy, with improving profit and operating margins and a healthy dividend providing good evidence of sustained fundamental strength. That’s why I think that, even with the current bearish momentum, K’s value proposition is too good to ignore. Let’s take a look.

Fundamental Profile for K

Kellogg Company is a manufacturer and marketer of ready-to-eat cereal and convenience foods. The Company’s principal products are ready-to-eat cereals and convenience foods, such as cookies, crackers, savory snacks, toaster pastries, cereal bars, fruit-flavored snacks, frozen waffles and veggie foods. Its segments include U.S. Morning Foods, which includes cereal, toaster pastries, health and wellness bars, and beverages; U.S. Snacks, which includes cookies, crackers, cereal bars, savory snacks and fruit-flavored snacks; U.S. Specialty, which represents food away from home channels, including food service, convenience, vending, Girl Scouts and food manufacturing; North America Other, which includes the U.S. Frozen, Kashi and Canada operating segments; Europe, which consists of European countries; Latin America, which consists of Central and South America and includes Mexico, and Asia Pacific, which consists of Sub-Saharan Africa, Australia and other Asian and Pacific markets. K’s current market cap is $20  billion.

  • Dividend Yield: K’s dividend is $2.28 per share, which translates to an annual yield of about 3.94% at the stock’s current price.
  • Debt/Equity: K has a debt/equity ratio of 1.95. This is a high number, and makes them one of the most heavily leveraged stocks in the Food Products industry. Their balance sheet indicates that in the last quarter, cash and liquid assets were a little over $1.5 billion, versus $7 billion in long-term debt. That actually marks a significant improvement from the latter part of 2019, when cash was $340 million against $8.5 billion in long-term debt. This is a solid confirmation not only that profitability is improving, but also that their balance sheet is getting stronger.
  • Earnings/Revenue Growth: Over the last twelve months, earnings declined about -11.65%, while revenues were 1.69% higher. In the last quarter, earnings we -26.61% lower, while sales declined -1.04%. Despite the negative earnings pattern, the company operates with a margin profile that is strengthening, which is a positive counter that suggests the company is becoming more efficient. Over the last twelve months, Net Income during was 8.8% of Revenues, and increased in the last quarter, to 10.15% of Revenues.
  • Free Cash Flow: K’s free cash flow is about $1.36 billion and translates to a Free Cash Flow Yield of 6.88%. It should also be noted that Free Cash Flow has improved steadily in each quarter of the past year, from about $590 at the end of 2019.

Value Proposition for K

  • Current Price versus Historical Levels: After dropping to about $60 in September, the stock temporarily rallied before peaking again at $66 and resuming its downward trend. That includes an acceleration of bearish momentum in the latter part of 2020, finding support in mid-January at around $57, where it saw a quick, hard rally (like a lot of Food companies) last week to a quick peak at around $62 before dropping back again. The stock is now about $1.50 above support at $57, with immediate resistance at around $60. A drop below $57 would give the stock room to keep dropping to about $53, where the stock 52-week, bear market low sits, while a push above $60 should find next resistance at around $62.
  • Value Proposition: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $89 per share, which means that K is extremely undervalued, with about 55% upside from its current price. I should also mention that in mid-2020, this same analysis offered a $79 long-term target price.

As always, remember that by making this trade, I am saying that I would be happy to buy this stock at $57.50 per share. Based on the value information above, I think this is a very good price for a stock with solid fundamentals behind it. If the stock is below $57.50 at expiration, I will accept the assignment for those shares. If you don’t want to deal with a potential assignment from a put sale, you shouldn’t make this trade.

If you prefer to make this trade a little more conservative, you can also consider using the following Bull Put Spread trade instead of a straight put sale:

  • Put Sale Leg: Sell the February Week 3 (expires 2/19) $57.50 Put.
    • Current Bid: +$1.20 (Credit)
  • Put Buy Leg: Buy the February Week 3 (expires 2/19) $55 Put.
    • Current Ask: -$.70 (Debit)
  • Net Credit: $.50
  • Yield on committed capital: .08% (11.2% annualized)
  • This trade expires in 17 days.

One of the big reasons I think a Bull Put spread could be smart for this stock right now is because with the long, $55 Put on the lower leg, there is a cap on how much downside you have on this trade. If the stock is below $55 at expiration, the maximum loss is $2.00 per share ($2.50 difference between $57.50 and $55, minus the $.50 premium brought in). That is true no matter how volatile the stock gets between now and then, or how far it drops. It also gives the stock some room to stabilize between its current price and $55, which is why you may consider simply accepting the assignment if it is between $57.50 and $55 at expiration; that could set up a useful opportunity to buy the stock at a great price and be in a useful, profitable position when the stock starts to move back to the upside.

If you would like to work with K but don’t want to sell a put option, or you aren’t approved for put selling, you may consider using the covered call trade below as an alternative. Please keep in mind that all pricing information displayed in this post is only current as of this writing; you will see different pricing from your broker.

  • Covered Call: buy the stock at its current price, then sell the February Week 3 (expires 2/19) 60 Call
    • Current Bid: $1.00
  • Return, not called out: 1.71%
  • Called out return: 4.52%
  • This trade expires in 17 days.

Keep in mind also that K is scheduled for its next earnings report next week, February 11 – eight days before this trade’s expiration date. If you aren’t comfortable holding an open position through an earnings report, you shouldn’t make this trade.

If you are a new subscriber, please take some time to review the videos in the Getting Started area of the website. These will give you a pretty comprehensive view of the value-oriented approach I use to generate income with put selling and covered calls. You will also find it useful to read my Frequently Asked Questions article. Also feel free to review my previous posts as you’ll find additional answers to many of the questions you may have.

2 thoughts on “Rebel Income Put Sale of the Week: Kellogg Co (K)”

  1. garycrawford.et@comcast.net

    When I see the oveerall trend going down, I’m hesitant to sell a put as it would turn into a loss. your reasoning for why it should turn around is compelling, but not convincing. I’ll wait a few days to see if your projection will change, where I would probably sell the put and close my put position.

    1. Hi Gary,

      Different viewpoints of a stock’s price action – and possibly different objectives for any given single trade we might be considering – are the reasons that I think it’s great when you can use information we provide from our alerts and compare it against your own preferences. I certainly don’t expect you to make exactly the same trade I do in exactly the same way; but if using K for this week’s Rebel Income trade gave you an opportunity to decide on another strategy that is useful for you, then I think we’re still moving in the right direction overall.

      Note that for me, put selling isn’t just about the put sale alone, but also about setting up a potential buy of a company I like at a nice price. That’s part of the reason that downward trends like K’s don’t discourage me from thinking about generating income via put sales. If I think the stock already has a useful value at the price it was at when I highlighted the trade, then the strike price I use for the trade should represent an even better price for my purposes – even if the stock not only drops below that price to trigger the assignment, but even stays below that price for some time. Over the long term, the strong value proposition K is offering should work in my favor either way.

      Have a great day!

      Thomas

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