Kelloggs Financial Statement Analysis 2000-2005 - Case Study Example

Kellogg's Financial Analysis Introduction Generally, companies release their annual reports to show how well they are doing in their business and inwhat position they are currently. Additionally, reports like the financial statements are so significant in also assessing the company's performance quarterly and annually. Kellogg's Company is without a doubt a known company with its worldwide distribution of its products. From 2000 to 2005, Kellogg's position has been greatly weighed through its quarterly and annually released reports that evidently impact both the customers as well as the competitors. It adds to the impression of the customers as to how well they're doing and at the same time gives challenge to its competitors. Executive Summary This section roughly discusses the financial performance in a six-year time (2000-2005). At a particular year, 2001, Kellogg Company released its own financial analysis of that year giving explanations and answers to the growth in the proceeding years. An apparent growth has been observed right from 2000 to 2005 in Kellogg's financial performance. Kellogg's Financial Statement Analysis Comparisons are often useful within a company to become aware of changes in financial relationships and significant trends. In the Intracompany Basis, a comparison of current year's cash amount with the prior year's cash amount shows either an increase or decrease. And within the span of 6 years (2000-2005), it is very useful to compare such cash amount from the first year (i.e. 2000) compared to the last year of comparison (i.e. 2005). Cash amount gained or lost may vary from 2000-2005. The proportion of total assets in the form of cash can be shown through a comparison of Kellogg's year-end cash amount with the amount total assets at year-end. Furthermore, in order to provide insight into Kellogg's competitive position, it is also practical to compare it with other companies. Correspondingly, Kellogg's total sales for the year can be compared with the total sales of its competitors such as Quaker Oats and General Mills which both obviously competes in the market. Taken as a whole, comparisons with industry averages will provide information about Kellogg's relative position within the industry. Then, Kellogg's financial data can be compared with the averages for its industry compiled by financial ratings organizations such as Dun & Bradstreet, Moody's, and Standard & Poor's. Kellogg's 2000 Financial Analysis In 2000, Kellogg Company achieved growth in net earnings and earnings per share, excluding charges, despite softness in the Company's U.S. convenience foods business, higher energy prices and interest rates, weak foreign currencies, and inventory write-offs in Southeast Asia. Through manufacturing efficiencies, reduced advertising and overhead expenses, and recognition of benefits related to U.S. tax credits, the Company was able to withstand despite such factors. 2000 1999 1998 Net earnings $597.7 $339.3 $502.6 Net earnings per share $1.45 $0.83 $1.23 Due to the previously stated factors or charges, there are exclusions from the results of operations in the following sections for purposes of comparison between years. The year 2000 and 1999 have been compared excluding charges, net earnings and earnings per share in the below table: 2000 1999 Charge Net earnings $651.9 $606.2 +7.5% Net earnings per share $1.61 $1.50 +7.3% The full-year increase in earnings per share of $0.11 consisted of $0.02 from business growth and $0.11 from favorable tax-rate movements, partially offset by $0.02 from unfavorable foreign currency movements. Kellogg's Company then continued to lead the global ready-to-eat cereal category in 2000 with an estimated 38% annualized share of worldwide dollar sales. Category share for the Company's operating segments was approximately 31% in the United States, 43% in Europe, 60% in Latin America, 45% in Canada, 57% in Australia, and 50% in Asia. The growth achieved by Kellogg's Company by the end of 2000 came from a struggling fourth quarter of 1999 that caused the volume results for 2000 in the following table: Change vs. prior year As reported Comparable business (a) Global cereal +1.0% +0.6% Global convenience foods -5.0% +1.4% Consolidated -0.5% +0.9% United States -2.4% +0.3% Europe -0.8% -0.8% Latin America +7.7% +7.7% Other operating +1.8% +1.4% Consolidated -0.5% +0.9% Kellogg's 2001 Annual Report Comprehensive Illustration of Ratio Analysis In this appendix this article provides a comprehensive review of those ratios and discusses some important relationships among them. Since earlier chapters demonstrated the calculation of each of these ratios, in this chapter we instead focus on their interpretation. Page references to prior discussions are provided if you feel you need to review any individual ratios. The financial information in Illustrations 13A-1 through 13A-4 was used to calculate Kellogg's 2001 ratios. You can use these data to review the computations. Illustration 13A-1Kellogg Company's balance sheet As indicated in the chapter, for analysis of the primary financial statements, ratios can be classified into three types: Liquidity ratios: Measures of the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. Solvency ratios: Measures of the ability of the enterprise to survive over a long period of time. Profitability ratios: Measures of the income or operating success of an enterprise for a given period of time. Illustration 13A-2Kellogg Company's income statement Illustration 13A-3Kellogg Company's statement of cash flows Illustration 13A-4 Additional information for Kellogg Company As a tool of analysis, ratios can provide clues to underlying conditions that may not be apparent from an inspection of the individual components of a particular ratio. But a single ratio by itself is not very meaningful. Accordingly, in this discussion we use the following comparisons: Intracompany comparisons covering two years for Kellogg Company (using comparative financial information from Illustrations 13A-1, 13A-2, and 13A-3). Intercompany comparisons using General Mills as one of Kellogg's principal competitors. Industry average comparisons based on Robert Morris Associates' median ratios for manufacturers of flour and other grain mill products and comparisons with other sources. For some of the ratios that we use, industry comparisons are not available. (These are denoted "na.") Liquidity Ratios Liquidity ratios measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. Short-term creditors such as bankers and suppliers are particularly interested in assessing liquidity. The measures that can be used to determine the enterprise's short-term debt-paying ability are the current ratio, the current cash debt coverage ratio, the receivables turnover ratio, the average collection period, the inventory turnover ratio, and average days in inventory. Current ratio. The current ratio expresses the relationship of current assets to current liabilities, computed by dividing current assets by current liabilities. It is widely used for evaluating a company's liquidity and short-term debt-paying ability. The 2001 and 2000 current ratios for Kellogg and comparative data are shown in Illustration 13A-5. Illustration 13A-5 Current ratio What do the measures tell us Kellogg's 2001 current ratio of .86 means that for every dollar of current liabilities, Kellogg has $0.86 of current assets. We sometimes state such ratios as .86:1 to reinforce this interpretation. Kellogg's current ratio-and therefore its liquidity-increased significantly in 2001. It is well below the industry average but higher than that of General Mills. Current cash debt coverage ratio. A disadvantage of the current ratio is that it uses year-end balances of current asset and current liability accounts. These year-end balances may not be representative of the company's current position during most of the year. A ratio that partially corrects for this problem is the ratio of cash provided by operating activities to average current liabilities, called the current cash debt coverage ratio. Because it uses cash provided by operating activities rather than a balance at one point in time, it may provide a better representation of liquidity. Kellogg's current cash debt coverage ratio is shown in Illustration 13A-6. Ratio Analysis The apparent simplicity of the current ratio can have real-world limitations because adding equal amounts to both the numerator and the denominator causes the ratio to decrease. Assume, for example, that a company has $2,000,000 of current assets and $1,000,000 of current liabilities; its current ratio is 2:1. If it purchases $1,000,000 of inventory on account, it will have $3,000,000 of current assets and $2,000,000 of current liabilities; its current ratio decreases to 1.5:1. If, instead, the company pays off $500,000 of its current liabilities, it will have $1,500,000 of current assets and $500,000 of current liabilities; its current ratio increases to 3:1. Thus, any trend analysis should be done with care because the ratio is susceptible to quick changes and is easily influenced by management. Illustration 13A-6Current cash debt coverage ratio Like the current ratio, this ratio increased in 2001 for Kellogg. Is the coverage adequate Probably so. Kellogg's operating cash flow coverage of average current liabilities is twice that of General Mills, and it exceeds a commonly accepted threshold of .40. No industry comparison is available. Receivables turnover ratio. Liquidity may be measured by how quickly certain assets can be converted to cash. Low values of the previous ratios can sometimes be compensated for if some of the company's current assets are highly liquid. How liquid, for example, are the receivables The ratio used to assess the liquidity of the receivables is the receivables turnover ratio, which measures the number of times, on average, receivables are collected during the period. The receivables turnover ratio is computed by dividing net credit sales (net sales less cash sales) by average gross receivables during the year. The receivables turnover ratio for Kellogg is shown in Illustration 13A-7. Illustration 13A-7Receivables turnover ratio We have assumed that all Kellogg's sales are credit sales. The receivables turnover ratio for Kellogg rose in 2001. The turnover of 12.0 times compares favorably with the industry median of 11.6, and is much higher than General Mills' turnover of 8.58. In some cases, the receivables turnover ratio may be misleading. Some companies, especially large retail chains, issue their own credit cards. They encourage customers to use these cards, and they slow their collections in order to earn a healthy return on the outstanding receivables in the form of interest at rates of 18% to 22%. In general, however, the faster the turnover, the greater the reliance that can be placed on the current ratio for assessing liquidity. Average collection period. A popular variant of the receivables turnover ratio converts it into an average collection period in days. This is done by dividing the receivables turnover ratio into 365 days. The average collection period for Kellogg is shown in Illustration 13A-8. Illustration 13A-8 Average collection period Kellogg's 2001 receivables turnover of 12.0 times is divided into 365 days to obtain approximately 30.4 days. This means that the average collection period for receivables is about 30 days. Analysts frequently use the average collection period to assess the effectiveness of a company's credit and collection policies. The general rule is that the collection period should not greatly exceed the credit term period (i.e., the time allowed for payment). General Mills' average collection period is significantly longer than those of Kellogg and the industry. This difference may be due to less aggressive collection practices, but it is more likely due to a difference in credit terms granted. Inventory turnover ratio. The inventory turnover ratio measures the number of times on average the inventory is sold during the period. Its purpose is to measure the liquidity of the inventory. The inventory turnover ratio is computed by dividing the cost of goods sold by the average inventory during the period. Unless seasonal factors are significant, average inventory can be computed from the beginning and ending inventory balances. Kellogg's inventory turnover ratio is shown in Illustration 13A-9. Illustration 13A-9Inventory turnover ratio Kellogg's inventory turnover ratio increased in 2001. The turnover ratio of 8.1 times is higher than the industry average of 6.9 and significantly better than General Mills' 5.6. Generally, the faster the inventory turnover, the less cash is tied up in inventory and the less the chance of inventory becoming obsolete. Of course, a downside of high inventory turnover is that the company can run out of inventory when it is needed. Days in inventory. A variant of the inventory turnover ratio is the days in inventory, which measures the average number of days it takes to sell the inventory. The days in inventory for Kellogg are shown in Illustration 13A-10. Illustration 13A-10Days in inventory Kellogg's 2001 inventory turnover ratio of 8.1 divided into 365 is approximately 45.1 days. An average selling time of 45 days is faster than the industry average and significantly faster than that of General Mills. Some of this difference might be explained by differences in product lines across the two companies, although in many ways the types of products of these two companies are quite similar. Inventory turnover ratios vary considerably among industries. For example, grocery store chains have a turnover of 10 times and an average selling period of 37 days. In contrast, jewelry stores have an average turnover of 1.3 times and an average selling period of 281 days. Within a company there may even be significant differences in inventory turnover among different types of products. Thus, in a grocery store the turnover of perishable items such as produce, meats, and dairy products is faster than the turnover of soaps and detergents. As a final point, nearly all of these liquidity measures suggest that Kellogg's liquidity increased during 2001. Its liquidity appears acceptable when compared to the industry as a whole and much better than that of General Mills. Solvency Ratios Solvency ratios measure the ability of the enterprise to survive over a long period of time. Long-term creditors and stockholders are interested in a company's long-run solvency, particularly its ability to pay interest as it comes due and to repay the face value of debt at maturity. The debt to total assets ratio, the times interest earned ratio, and the cash debt coverage ratio provide information about debt-paying ability. In addition, free cash flow provides information about the company's solvency and its ability to pay additional dividends or invest in new projects. Debt to total assets ratio. The debt to total assets ratio measures the percentage of the total assets provided by creditors. It is computed by dividing total liabilities (both current and long-term) by total assets. This ratio indicates the degree of financial leveraging. It also provides some indication of the company's ability to withstand losses without impairing the interests of its creditors. The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations. The lower the ratio, the more equity "buffer" is available to creditors if the company becomes insolvent. Thus, from the creditors' point of view, a low ratio of debt to total assets is desirable. Kellogg's debt to total assets ratio is shown in Illustration 13A-11. Illustration 13A-11Debt to total assets ratio Kellogg's 2001 ratio of .92 means that creditors have provided financing sufficient to cover 92% of the company's total assets. Alternatively, it says that Kellogg would have to liquidate 92% of its assets at their book value in order to pay off all of its debts. Kellogg's 92% is above the industry average of 59% as well as the 78% ratio of General Mills. Kellogg's solvency declined during the year. In that time, Kellogg's use of debt financing changed in two ways: First, Kellogg increased its use of long-term debt by 384%, and second, its equity decreased slightly. Both these factors reduced its solvency. The adequacy of this ratio is often judged in light of the company's earnings. Generally, companies with relatively stable earnings, such as public utilities, have higher debt to total assets ratios than cyclical companies with widely fluctuating earnings, such as many high-tech companies. Another ratio with a similar meaning is the debt to equity ratio. It shows the relative use of borrowed funds (total liabilities) compared with resources invested by the owners. Because this ratio can be computed in several ways, care should be taken when making comparisons. Debt may be defined to include only the non-current portion of liabilities, and intangible assets may be excluded from stockholders' equity (which would equal tangible net worth). If debt and assets are defined as above (all liabilities and all assets), then when the debt to total assets ratio equals 50%, the debt to equity ratio is 1:1. Times interest earned ratio. The times interest earned ratio (also called interest coverage) indicates the company's ability to meet interest payments as they come due. It is computed by dividing income before interest expense and income taxes by interest expense. Note that this ratio uses income before interest expense and income taxes because this amount represents what is available to cover interest. Kellogg's times interest earned ratio is shown in Illustration 13A-12. Illustration 13A-12Times interest earned ratio For Kellogg the 2001 interest coverage was 3.3, which indicates that income before interest and taxes was 3.3 times the amount needed for interest expense. This exceeds the rate for General Mills, but it is less than half the average rate for the industry. The debt to total assets ratio increased for Kellogg during 2001, and its times interest earned ratio declined dramatically. These ratios indicate that Kellogg is less able to service its debt. Cash debt coverage ratio. The ratio of cash provided by operating activities to average total liabilities, called the cash debt coverage ratio, is a cash-basis measure of solvency. This ratio indicates a company's ability to repay its liabilities from cash generated from operating activities without having to liquidate the assets used in its operations. Illustration 13A-13 shows Kellogg's cash debt coverage ratio. Illustration 13A-13 Cash debt coverage ratio An industry average for this measure is not available Kellogg's.17 is higher than General Mills' .10, but it did decline from .22 in 2000. One way of interpreting this ratio is to say that net cash generated from one year of operations would be sufficient to pay off 17% of Kellogg's total liabilities. If 17% of this year's liabilities were retired each year, it would take approximately six years to retire all of its debt. It would take General Mills approximately ten years to do so. A general rule of thumb is that a measure above .20 is acceptable. Free cash flow. One indication of a company's solvency, as well as of its ability to pay dividends or expand operations, is the amount of excess cash it generated after investing to maintain its current productive capacity and paying dividends. This amount is referred to as free cash flow. For example, if you generate $100,000 of cash from operations but you spend $30,000 to maintain and replace your productive facilities at their current levels and pay $10,000 in dividends, you have $60,000 to use either to expand operations or to pay additional dividends. Kellogg's free cash flow is shown in Illustration 13A-14. Illustration 13A-14 Free cash flow Kellogg's free cash flow declined considerably from 2000 to 2001. In fact, it was negative in 2001. During 2001, Kellogg used a large portion of free cash flow to acquire Keebler Foods. It is unlikely that Kellogg will have a similar large purchase in the near future (www.kelloggs.com). Kellogg's Year-end Report 2003 Within the second week of December 2003, Kellogg breakfast cereal maker released an optimistic trading statement bringing a little bit of Christmas cheer at the end of a year which has been perceived as tough year for most international food companies. Kellogg had expected an increase in profits for 2003, raising its own earnings per share expectations to $1.90-1.92 from $1.89-1.91, claiming "business momentum and lower taxes" as the reason for the confidence. Kellogg's chairman and chief executive officer Carlos Gutierrez said that the company would utilize the money saved as a result of its lower taxation rate this year to invest in further brand building and further cost saving measures. Gutierrez added that he expected the company to take a fourth quarter charge of $0.07-0.09 per share relating to the closing of a snacks plant in Australia, a change in crewing in a European cereal plant, the outsourcing of a US repackaging operation and the closing of a cereal plant in Argentina, among others. According to Gutierrez, the company had also decided to use its stronger-than-anticipated cash flow to repurchase $150-200 million of outstanding bonds, with an up-front cost of $0.03 in the fourth quarter of 2003. Nevertheless, Gutierrez said that such move would bring debt reduction for the full year to around $500 million, well ahead of expectations, and create interest-expense savings in 2004 and beyond. Such factors are believed to produce savings in 2004, which can help to further offset the impact of expected substantial increases incommodities and benefits costs. This is in line to the continuous rise of commodity and benefits costs with Kellogg's current momentum and reinvestment giving confidence in its 2004 outlook. Gutierrez added that the company is expecting another good year as they build on strong underlying earnings power. For the reason that Kellogg's operation is in Europe, it has greatly benefited in 2003 because of the relative weakness of the US dollar against the euro. Kellogg's 2004 Financial Analysis The Kellogg Company reported better-than-expected first quarter of 2004 earnings. It marked an astounding 34% higher than the last year period on the strength of 11% sales growth. The strong start prompted Kellogg earlier in April 2004 to raise to its earnings expectations for the full year, notwithstanding the ongoing commodity-cost inflation and the Company's decision to acquire increased asset writer-offs and up-front costs related to additional cost-reduction projects. Kellogg's net earnings for the quarter of 2004 reached $219.8 million, or $0.53 per diluted share, a 34% increase from last year's $163.9 million, or $0.40 per share. Such performance was largely due to sales growth momentum across the Company, a result of brand-building investment, successful product innovation, and solid execution. Not like the past year's remarks, Carlos Gutierrez commented that the year 2004 was truly an outstanding quarter in every respect attributing to exceptional and broad-based sales growth overcoming significantly higher commodity and benefits costs, and reinventing for the future by boosting brand building and absorbing related to cost-reduction projects. Above all, Kellogg Company was able to surpass their original forecasts for earnings and cash flow. Kellogg's 2004 Financial Performance In first quarter of 2004 marked Kellogg's outstanding quarter in every respect with exceptional and broad-based sales growth and overcoming significantly higher commodity and benefits costs. Reported net sales in the quarter increased by 11% to $2.4 billion. Internal net sales growth, which excludes foreign-currency translation, was 6.5%, the Company's highest internal growth rate in five years. Kellogg North America reported net sales growth of 6%, or 5% excluding the impact of foreign currency. The segment's retail cereal sales rose 4% in local currencies, as new products and effective consumer promotions drove category share gains in both the U.S. and Canada. Retail snacks posted local- currency sales growth of 6% in North America, led by new products in the U.S. and Canada. The North America Frozen & Alternative Channels businesses collectively posted local-currency sales growth of 4%, driven by gains by the Eggo and Morningstar Farms brands and the foodservice channel. Kellogg International reported net sales growth of 24% in the quarter, or 10% in local currencies. In Latin America, sales were up 17% on a local- currency basis, driven by strong growth in both cereal and snacks in Mexico. Europe's local-currency sales growth was 7%, led by cereal and snacks growth in the U.K. Sales in the Asia Pacific region were up 11% in local currencies, with notable gains in Japan and Australia. Operating profit was $420 million in the quarter, a 21% increase over the year-ago period. Higher net sales, a favorable product mix, and productivity savings more than offset the impact of increased raw materials prices and a double-digit increase in brand-building investment. Net earnings growth was augmented by the effect of lower interest expense and a modestly reduced effective tax rate. Cash flow, defined as cash from operating activities less capital expenditures, was $211 million in the quarter, exceeding the year-earlier quarter by 33 percent (www.investor.kelloggs.com). Cash Flow Analysis During the 2005 Fiscal Year, Kellogg's earnings estimate was $2.34 at the end of December. Correspondingly, the shares during that time were trading at $46, compared to its closing price of $47.31, and the P/E ratio was at 21, versus a current 19.5. Kellogg reported earnings of $2.36 per share, an increase of 10 percent from the $2.14 per share earned in 2004. It also was the company's fourth consecutive year of double-digit earnings growth. Net sales increased by 6 percent to $10.2 billion. The cereal giant reported that its gross margin for the year was maintained at 44.9 percent, while operating profit increased by 4 percent in 2005 to $1.8 billion after increasing by 9 percent the previous year. In 2005, free cash flow, defined as cash from operating activities less capital expenditures was $769 million. The company repurchased $664 million in stock in 2005 and its debt level remained essentially unchanged. The news gets even better for the first quarter of 2006. Earnings were 68 cents per share, an 11 percent increase over last year's 61 cents per share. Net sales for the quarter were up 6 percent to $2.7 billion. Free cash flow was $101 million. Kellogg also stated that it now expects full-year earnings of between $2.45 and 2.49 per share. Calculating Kellogg's intrinsic value, using an earnings approach, yields a value of $54.50, assuming an earnings growth rate of 9.74 percent and a discount rate of 11 percent, the average return on the S&P 500. If, instead of earnings, we use a more conservative free cash flow model, we obtain an intrinsic value of $54.51. As you can see the two models yielded virtually the same answer. Earnings estimate for Kellogg for 2006 is $2.56 per share. The current trailing 12-month P/E or multiple is 19.5. If the P/E remains unchanged, Kellogg should be trading at about $50 per share in the next nine months, for an annualized gain of 7.7 percent. In addition, Kellogg has a current dividend yield of 2.4 percent. However, Kellogg's board has approved a 5 percent increase in the dividend, to begin in the third quarter (Rudd 2006). Kellogg's 2005 Financial Analysis (Cash Flow) Cash flow, defined as cash from operating activities less capital expenditures, was $101 million in the first quarter, as was anticipated in our plan. The decline from the first quarter of last year was primarily the result of timing: the improvement made in trade payables as a percentage of sales in the first quarter of this year was less than last year's improvement. This difference was the result of an unusually low payables balance at the start of 2005. Core working capital measured as a percentage of rolling twelve-month sales was an industry-leading 7% at the end of the first quarter of 2006, which represented an improvement of 20 basis points from the first quarter of last year. Full-year cash flow is now expected to be in a range between $900 million and $975 million, an increase from previous expectations of $875 million to $975 million. In addition, the Company expects gross margin expansion. The Company also expects operating profit growth to equal or exceed sales growth for the full year. Leverage Analysis Year-to-date period ended April 1, April 2, 2006 2005 Operating activities Net earnings $274.1 $254.7 Adjustments to reconcile net earnings to operating cash flows: Depreciation and amortization 81.3 101.6 Deferred income taxes (8.7) (18.9) Other (a) 47.3 50.3 Postretirement benefit plan contributions (25.2) (54.7) Changes in operating assets and liabilities (205.0) (123.0) Net cash provided by operating activities 163.8 210.0 Economic Value-added Kellogg's promotional events included value-added offers brought to consumers by means of the trade and special pack inserts for the consumer. Major promotions are cautiously coordinated across all of Kellogg's departments. Significant areas include Finance, to budget for the campaign, Packaging, to ensure designs are attractive and Legal, to make sure contracts are tight and all advertising legal and truthful. The Consumer Promotions Team is the key Kellogg team responsible for effective communication between areas, developing original and creative ideas and managing and delivering the event. Kellogg's go to a great deal of trouble to make sure that what the consumer gets is an exciting and effective promotion. This takes teamwork, co-ordination, planning and communication. The success of a promotion is testimony to the effectiveness of the Kellogg's team. Conclusion Within the six-year financial analysis of the Kellogg's business performance, there is only one thing noticeable - growth. Right from the year 2000 when this article started the financial analysis, growth is constant on Kellogg's Company's financial performance despite some threats perceived from time to time and from place to place. There is no other way for Kellogg's than the way up. However, the company should always value the several ways in which they lead in the market atop its tough competitors. References Kellogg's Company. Annual Reports. Retrieved 26 June 2006 from www.kelloggs.com. Investor Relations - Kellogg's Company. Retrieved 26 June 2006 from http://investor.kelloggs.com/results.cfmQuarter=&Year=&navSection=Financials&navSubSection=All. Rudd, Lauren (2006 June 11). Streetwise: Kellogg's stock still has crackle and pop. Personal Business. Retrieved 27 June 2006 from www.post-gazette.com. Read More