The Financial Analysis from 2006 to 2010 of Kellogg - Research Paper Example

June 13, Security Analysis Report of Kellogg (stock ticker K Introduction The purpose of this paperis to study the stock of Kellogg by analyzing the 5 year financial history of the firm. This research aims to find out whether one should buy, sell or hold the company’s stock. The financial report from 2006 to 2010 includes five years, which need to be examined in order to know the stock movements in Kellogg. The company Kellogg is a leading producer and distributor of cereals, which was founded in the year 1906. The company’s name is listed on the New York Stock Exchange and the Dow Jones Stock Exchange. “The most common deciding factors used in the market to attempt to anticipate future stock pricing are recent price history and patterns, current price relative to past price levels or other stocks, beliefs about future price movement, and a fourth area that can be described generally as ‘reckless optimism” (Thomsett 1). 2. Discussion of background of the company. Kellogg is a leading producer and distributor of cereals, which was founded in the year 1906. From the year 1906 Kellogg had been expanding mainly by creating its own new brands of cereals, cornflakes, and other cereal related food products. The financial statement from 2006 to 2010 contains 5 years, which require to be inspected to recognize the stock activities in Kellogg. It is listed on the Dow Jones Stock Exchange and New York Stock Exchange. Kellogg’s had expanded over the years and has a good market share. Its stocks and share prices showed a very positive trend and investors were on a rush to invest in Kellogg stocks. Due to economic recession of 2007 like other companies kellogs socks also took a stagnat approach. So this paper investigates whether an investigator should invest in Kellogg’s shares by buying, or he should be holding his decision or in fact the investor should be selling Kellogg’s shares in the stock market. For this reason the firm’s five year analysis is being studied. Every investor wants to invest in perfect stock. There are a number of dimensions for measuring a stock’s performance. The growth of a firm, the margins in a business, the balance sheet of a firm, the return on equity, stock valuation and payment of dividends are some of the prime dimensions through which a stock is measured. A stock is considered as best or perfect only when all the dimensions are perfect and project a future growth for its investors. An expanding business has growing and healthy revenue. The stock movements are a projection of a business and past results are no guarantee yet the past stock records of a firm influence its present and future movements to a certain extent. A firm which has high sales does not mean it is earning high profits. High sales do not measure a stock’s performance, whereas the profits of a firm directly affect the stock movements. From the income statement of Kellogg, it is understood that the net sales from the year 2006 to 2008 show an increasing trend while the year 2009 and 2010 point out to a decreasing movement in net sales as compared to the previous year. From 2006 to 2008 there was an increase in net sales by around 18%. While in the year 2009 there was a drastic downfall by around 2%, similarly, the year 2010’s net sales also showed a decrease by 1.41% A consolidated average from the year 2006 to the year 2010 with respect to the net sales of the firm shows that Kellogg has experienced a growth of 13.66%. Comparing the net earnings of Kellogg there is an increase of 24%. In such a case, Kellogg stocks have to be brought. Comparing the net earnings of the years 2009 and 2010, there is a decrease of 2.9%. The profits of a firm are understood from its payment of dividends. A firm with a strong balance sheet does not have to worry about its debt. The return on equity helps to measure how well a firm is converting its resources into profitable business endeavors for expansion purpose. If the five-year annual revenue growth is more than 15%, then it implies that the firm is growing. Comparing last year also, if there is a comparative increase of 12% then the firm’s stocks is going strong. Similarly if the gross margin is more than 35% then it implies that the firm’s stocks make a good deal. In the balance sheet, if the debt-equity ratio of a firm is below 50%, then the stocks of the firm are going smoothly. Similarly if the return on equities is greater than 15% then it implies that the stocks of the firm can be bought. The price earning ratio is a good indicator of the stock movements. If the normalized price earning ratio is below than 20 then the stocks should be bought. The price earnings of Kellogg are good. With respect to payment of dividends if the current yield of dividends is more than 2% then it implies that the stocks is good and should be bought. Similarly, if the 5 year dividend growth is more than 10% then it implies that the stocks are positively and should be bought, while in the reverse case, the current yield of dividends is less than 2% and if the 5 year dividend growth is less than 10% then it implies that the stocks of the firm are not moving in the right direction and should be put on hold. It should be checked whether the current ratio of the firm is less than the industry average. If a firm's current ratio is below the industry average ratio then it indicates that the liquidity position of the company is weak. Kellogg’s current ratio is weak. The Earnings per share, (EPS) ratio is considered to be the most critical component in determining a share's price. Price Earnings of the business is a major indicator of its performance. “The P/E looks at the relationship between the stock price and the company’s earnings. The P/E is the most popular metric of stock analysis, although it is far from the only one you should consider” (Little par.2). When the price earning ratio is higher then it implies that the market is willing to pay for the firm’s earnings. Fall in profitability has resulted in lowered EPS. The Price to Book ratio or P/B looks at the value the market pegs on book value of shares. Normally, the lower the P/B the better performance of the business. P/B = Share Price / Book Value per share. The returns on equity measure the net income available to common equity shareholder as a percentage of equity capital. Since the Return on Equity is a major indicator of economic health of business, it is believed that it is necessary for the firm to improve its return on equity, which can be increased through productivity and lowered costs. The future of the firm looks good on an average but the firm needs to focus on measure to improve its revenue along with a decrease in its expenditure. Also its dependence on debt capital needs to be reduced in order to make a more profitable future. The Money Flow Index (IMF) is an indicator, which is used to analyze the current trend of price and volume of a given stock. The MFI is used to measure the strength of stock. The MFI is calculated by using the formula: Typical price is calculated by using the formula: Stock (high + low+ close) / 3 The money flow is calculated by using the formula: Typical price * volume Money ratio = positive money flow / negative money flow Money flow index = 100 – (100 / (1 + money ratio)) The stock details on December 2010 are: Open = 51.08 High = 51.28 Low = 51 Close = 51.08 Volume = 773,800 Typical price = (51.28 + 51 +51.08) / 3 = 51.12 Money flow = 51.12 * 773,800 = 39,556,656.000 Kellogg is the main producer of cereals in the US market and, therefore, it has high influence in the market. Like every firm, Kellogg has competitors and they are mainly from other US cereal companies. The main competitors are General Mills and Kraft foods. While Kellogg has a market share of 34%, its competitor General Mills has a share of 31%. 3. Financial conditions of Kellogg Company: Kellogg Company is the world's most important producer of cereal and a leading manufacturer of expediency foods including crackers, cookies, toaster pastries, fruit-flavored snacks, cereal bars, vegetarian foods and frozen waffles. Kellogg’s main brands contain Corn Flakes, Pop-Tarts, Keebler, Eggo, Nutri-Grain, Cheez-It, Rice Krispies, Morningstar Farms, Bear Naked, Famous Amos, All-Bran, Special K, Frosted Mini-Wheats, Kashi and Club. The products of Kellogg’s are contrived in 18 countries and advertised in excess of 180 countries around the world. Financial conditions can be defined as the current state of financial variables that influence economic behavior and (thereby) the future state of the economy. In theory, such financial variables may include anything that characterizes the supply or demand of financial instruments relevant for economic activity. Financial ratios and DuPont analysis of the company: Financial ratio is a comparative degree of two particular mathematical values taken from an enterprise's financial reports. There are a lot of financial ratios used by forecasters to evaluate different attributes of a Kellogg’s financial power or working outcome. They all engross the assessment of elements from an income statement or balance sheet, and are crafted among specific points of focus in mind. Return on Investment (ROI) or Profitability: ROI consist Gross profitability, Net profitability, Return on assets, Return on investment and Earnings per share. Gross profitability calculates of manufacturing effectiveness. Net profitability dealings the overall effectiveness of the Kellogg. Return on assets point out how successfully the Kellogg is deploying its possessions. Return on investment shows how well the Kellogg Company is using its equity investment. An earnings per share states further evaluation to market value of stock. Liquidity: Liquidity consist Current ratio, Quick ratio and Cash to total assets. Current ratio measures the capability of an entity to disburse its near-term requirements. Quick ratio measures an additional strict definition of the Kellogg's ability to create expenses on current requirement. Cash to total assets measures the segment of a Kellogg's assets detained in marketable securities. Leverage: Leverage consist Debt/equity ratio, Debt ratio and Interest coverage. Debt/equity ratio indicates the relative mix of the Kellogg's investor-supplied resources. Debt ratio shows the part of a Kellogg's capital that is provided by borrowing. Interest coverage measures how comfortably the Kellogg can hold its interest payments. Inventory and Receivables Management: It consist Inventory turnover ratio, Inventory holding period, Inventory to assets ratio, Accounts receivable turnover and collection periods. Inventory turnover ratio shows how efficiently the Kellogg is running its warehousing, production and distribution of product, allowing for its capacity of sales. Inventory holding period computes the quantity of days, on average, that elapse among sale of product and finished goods production. Inventory to assets ratio shows the portion of assets joined up in inventory. Accounts receivable turnover provides a measure of how rapidly credit sales are twisted into cash. And Collection period shows the average quantity of days the Kellogg’s receivables are excellent, among the dates of collection of cash and credit sale. The table 3 shows the trend analysis of Kellogg Company. The case of liquidity ratio, current ratio along with higher liquidity during 2009 and lowers in 2006 are shown. Quick Ratio shows higher liquidity during 2009 and a lower one in 2006 at the range of 0.720, 0.399 respectively. The higher coverage area during 2010 and compared to the lower one in 2006. In the case of efficiency, Inventory Turnover shows higher efficiency, since the period of 2008 and lowers in 2010. Total Asset Turnover illustrates increased efficiency since 2008 and decreased efficiency during 2006. Fixed Asset Turnover shows increased efficiency since during 2008 and decreased efficiency since 2006. In the case of leverage, DEBT shows increased leverage in the period of 2008 and Drop in leverage since 2007 and higher coverage during 2010 and lowers in 2006. The entire trend analysis shows that the market value of the Kellogg is good. DuPont Analysis: The DuPont analysis is a process for measuring a company's (ROE) return on equity. It is significant to recognize how the company's efficiency, profitability and leverage are related in its financial performance. “The company's return on assets, ROA (=net income/assets), can be expressed as: ROA = (Net Income/Revenue) * (Revenue/Assets) = Profit Margin * Asset Turnover And the company's return on equity, ROE (=net income/equity), can be expressed as ROE = (Net Income/Revenue) * (Revenue/Assets) * (Assets/Equity) = ROA * Equity Multiplier” (Hsu par.6). The table 4 shows the DuPont Analysis of Kellogg. In the case of profit margin shows that higher profitability since 2008 and lowers in 2008. Asset Turnover shows higher efficiency during 2008 that was less in 2006. Return on Assets (ROA) increase in the period of 2009 and fall in 2006. Return on Equity Turn over 2008 and turn down in 2007. Comparative analysis of Kellogg: Comparative analysis means the item-by-item assessment of two or more similar alternatives, products, processes, qualifications, systems or sets of data. In accounting, for instance, alterations in a financial reports things in excess of a number of accounting periods possibly accessible together to identify the rising trends in the industries procedures and results. The main competitors of the Kellogg are General mills and Kraft foods. See the comparability analysis of Kellogg, General mills and Kraft foods. The table 5 represents the comparative analysis of the Kellogg. Comparing the competitors, General Mills and Kraft foods, Kellogg provides high profitability, high ROA and high ROE. 4. Analysis of Common Sized Income Statement of Kellogg: Common size Income Statements are used to evaluate financial reports of different- size industries or of the same industry over changed periods. Following is the calculation of common size income statement. The table 6 shows Common size Income Statement of Kellogg Company. It expresses all line items scaled by incomes. Common size income statement examines permits an analyst to decide how the different components of the income statement influence a company's income. In the case of Common Size Income Statement, net sales is taken as 100%, Cost of Sales taken as 53%, Gross Profit shows 47%, SG&&A shows 27%, Interest Expense shows 2.4%, Total Taxes as 29% and net income shows 9.4% respectively. 5. Regression analysis of Kellogg Company: The regression of Kellogg’s sales against two variables leads to the forecast of the firm’s sales. Comparing the sales with the two economic variables GDP and net income. It leads to the understanding that regression of sales with respect to the GDP shows a projection for the year 2011 is 4.86% while regressing the sales with the net income shows 1.43%. The two economic variables of GDP and net income were chosen because they are highly significant economic variables and affect the stock movements of a firm. From 2006 to 2010, there has been an increase in GDP of 9.4%. GDP is the most macroeconomic data and is a key variable in a country because it is used to measure the material well being as well as to improve economic productivity. Similarly net income of the firm is the most important requirement in the firm, which is used to understand the stock movements and whether to buy, hold or sell the stock. The regression analysis is a proof of how the company’s sales are dependent upon the two economic variables and time. The sales of a firm are a dependent factor while the two economic variables are independent factors. The regression sales are used to make future forecasts of sales in the corresponding years. The regressions analysis done in 2009 can act as a catalyst for determining the sales target in 2010. 6. Analysis of Pro forma income statements: Pro forma income statements are the significant instruments for planning future business controls, which assist the financial manager in the arrangement of the company’s financial requirements. It creates working changes such as decreasing costs or increasing prices before the projections become realism. It gives invaluable information about choices and future trends. Pro forma income statements provide an important benchmark or budget for operating a business throughout the year. They can decide whether expenses can be accepted to run advances in the first sector of the year than in the second. They can resolve whether or not the advertising campaigns require an additional increase throughout the fall months. The Kellogg uses pro forma income statements in the procedure of business control and planning. For the reason that pro forma income statements are obtainable in a columnar format, standardized, management employs them to contrast and compare different business plans. By preparing the information for the financial and operating reports side-by-side, organization study the projected outcomes of competing strategy to make a decision which greatest serves the interests of the dealings. Table 7 shows the Pro forma income statements. It shows the level of sales, net income, inventory, SG&&A for the years 2006 to 2010. Sales were 49% for 2010 and 2011. Average of last three years, inventory has been .26% of sales. Thus, specified the sales forecast of $449, inventory is forecasted to be $544.77 = 0.294. Average accounts payable have been 5.8% of sales and, therefore, accounts payable is estimated to be $ 6,005.77 =0.587. 7. Calculation and discussion of the company’s cost of equity: The cost of equity is the return a firm hypothetically pays to its equity investors, for instance, investors to find their resources. “The Cost of Equity (COE) is the minimum rate of return shareholders require for their investment in common stock of a corporation. This expected future return to the investor consists of both capital gains (share price appreciation) and dividends. The cost of equity formula helps investors determine the cost of capital which equates the current share price with the discounted value of future dividends from the company in perpetuity” (Calculate and Interpret the Cost of Equity par. 1). Calculation of cost of equity Cost of Equity = ((Stock Price Appreciation+ Dividend for Next Year) / Current Share Price)) + Dividend Growth Rate ((1.598+ 624)/ 1.606)) + 24.49 = 25.00%. 8. Discuss the assumptions and the results of common stock: Common stock is an appearance of business equity possession, a type of safety. It is called "common" to differentiate the starting favored stock. In the event of insolvency, common stock shareholders receive their resources after favored bondholders, creditors, stockholders and such conversely receive common shares on average, which is better than favored bonds or shares over time. Kellogg Company's trade is generally separated into two divisions: Kellogg International and Kellogg North America. Kellogg International is separated into businesses in Latin America, Europe and Australia and Asia. Kellogg North America Contains retail snacks, retail cereal and specialty channels trades in both the Canada and US. The term Securities of the company represents equity ownership in Kellogg. Common shares allow a shareholder vote on such topics as a voting of directors. They also provide the possessor a share in a Kellogg’s profits by means of capital appreciation of the security or dividend payments. Table 8 shows Kellogg’s common stock. P/E presents price to earnings ratio, P/S shows price/sales ratio. P/CF represents price/cash flow. The current P/E, P/S and P/CF show 17.043, 1.606 and 12.848 respectively. The 5 year average shows 16.934, 1.598 and 12.728. Industry represents 20.5, 94.3 and 14.3. Kellogg analyzed S&P 500 shows 19.3, 2.2 and 15.1 respectively. In the period of 2009, Kellogg shows the incomes of $12.6 billion, net revenues of $1.20 billion and turn down of 2%. For the Comparison Group, General Mills and Kraft foods analyzed the amount of shares outstanding, percentage of economic ownership, market capitalization and percentage of voting shares among the lower voting class common stock and advanced voting class common stock. Kellogg noted that the lesser selection class common stock of the assessment Group was the further liquid stock class based on the higher market capitalizations and advanced number of shares outstanding, in spite of the financial and voting differences among the classes of stock issued by the industries. 9. Recommendations: The economy is dynamic and thus is the stock movements. There is not accurate prediction yet whether to buy, sell or hold the stock through the financial analysis of the firm. Analyzing the firm Kellogg’s and its financial data from the year 2006 to 2010, it is advisable to buy the stock. One of the main reasons for this is that even though the firm has deteriorating sales in the past two years yet its decreases have not been as severe as compared to the firm’s revenue generation for the past three years. The firm shows an increasing trend of payment of dividend and, thus, it is reasonable to buy the stocks. Before a stock is bought it needs long-term analysis and if such an analysis is done of the Kellogg stock then Kellogg can be said to have an impressive performance from the last many years since its establishment. The present price of Kellogg is low, but that does not imply that the firm’s share prices will not increase because the firm has a good market share. Also its competitors General Mills and Kraft foods, even though are increasing their market share, yet Kellogg has a more established market share. Also the analysis of price earnings per share, dividend payments, future projection with regression of two economic variables and the price debt equity ratio all point out that even though the performance of the firm is down at the moment, it is not just fearing and could be considered as a part of economic recession. The question of putting a stock on hold arises when the stock’s performance over the years has been stagnant but that is not the case of Kellogg because till the year 2008 the firm has been on a high financial record. The question of non-purchase of stock or selling a stock arises when the stock’s value is high, but this is also no the case here because the price of Kellogg stock is down at the moment. Therefore it is advisable that investors should purchase the stocks of Kellogg’s. Appendix Table 1 Synopsis of Income statement of Kellogg from 2006 – 2010 Heads (in $ millions) 2010 2009 2008 2007 2006 Net sales 12397 12575 12822 11776 10,907 Cost of goods sold 7108 7184 7455 6597 6082 Selling general and administrative exp. 3299 3390 3414 3311 3059 Operating profit 1990 2001 1953 1868 1766 Interest exp. 248 295 308 319 307 Earnings before Income tax 1742 1684 1633 1547 1472 Income tax 502 476 485 444 467 Net earnings 1247 1212 1148 1103 1004 Table 2 Synopsis of Balance sheet of Kellogg from 2006 – 2010 Heads 2010 2009 2008 2007 2006 Total current assets 2915 2558 2521 2702 2427 Total assets 11847 11200 10946 11397 10714 Total current liabilities 3184 2288 3552 4044 4020 Total debt 4908 4835 4068 3270 3053 Total equity 2154 2275 1455 2526 2069 Total liabilities And equity 11847 11200 10946 11397 10714 Table 3. Kellogg Trend Analysis. Performance area. 2010 2009 2008 2007 2006 Trend Liquidity: Current Ratio 0.916 1.118 0.710 0.672 0.604 Lower liquidity since 2006 Quick Ratio 0.584 0.720 0.457 0.443 0.399 Lower liquidity since 2006 Internal measure(days) 35.037 31.725 32.537 31.801 31.618 Lower coverage during 2006 Efficiency: Inventory Turnover 11.740 13.819 14.294 12.745 13.238 Lower efficiency since 2010 Total Asset Turnover 1.046 1.123 1.171 1.033 1.018 Increased efficiency since 2008 Fixed Asset Turnover 3.963 4.178 4.372 3.938 3.874 Increased efficiency since 2008 Leverage: DEBT 0.818 0.797 0.868 0.778 0.807 Drop in leverage since 2007. Times Interest Earned 8.340 8.133 6.439 6.096 5.959 Lower coverage during 2006. Table 4. DuPont Analysis Item/Ratio 2010 2009 2008 2007 2006 Evaluation Net Income(in million) 1,247.000 1,212.000 1,148.000 1,103.000 1,004.100 Assets (in millions) 11,847.000 11,200.000 10,946.000 11,397.000 10,714.000 Equity (in millions) - - 6.000 7.000 - Profit Margin %  0.462 0.467 0.451 0.473 0.482 Fall in profitability since 2008. Asset Turnover 1.046 1.123 1.171 1.033 1.018 Lower efficiency during 2006. Return on Assets % 0.105 0.108 0.105 0.097 0.094 Fall in ROA since2006. Return on Equity % 0.578 0.533 0.793 0.437 0.485 Turn down in ROE during 2007. Table 5. Comparative analysis Performance area Kellogg General mills Kraft foods Evaluation. Profitability: Gross Profit Margin 0.467 0.397 0.366 High profitability. Return on Assets 0.102 0.088 0.031 High ROA. Return on Equity (%) 0.565 0.279 0.085 High ROE. Table 6/: Common Size Income Statement: Items Common Size Income Statement of average 5 years. Sales 1.000 Cost of Sales 0.533 Gross Profit 0.467 SG&&A 0.269 Interest Expense 0.024 Total Taxes 0.294 Net Income 0.094 Table 7: Pro forma income statements Income statement 2010 assumptions 2011 Sales(million) 12,397 0.049 12999.4942 Less Cost of Sales 6,671 0.538 6,993.73 Gross Profit 5,726 6,005.77 SG&&A 3,249 0.264 3,435.64 EBITDA 2,477 2,570.13 Less Depreciation 392 0.031 403.8462783 EBIT 2,085 2,166.28 Interest Expense 250 0.024 `315.9279896 Nonop Income/Expense (6.000) 0 Special Items (87.000) 0 Pre-tax Income EBT 1,742. 1,850.35 Total Taxes 502.000 0.294 544.77 Minority Interest (7.000) 0 Income Bef Extra Items 1,247 1,305.59 Net Income 1,247 1,305.59 Table 8: Valuation of the Kellogg’s common stock Current 5 Year Avg. Industry S&P 500 P/E 17.043 16.934 20.5 19.3 P/S 1.606 1.598 94.3 2.2 P/CF 12.848 12.728 14.3 15.1 Table 9: Changes in stock prices from 2006 - 2010 Change in stock prices 2010 2009 2008 2007 2006 Stock price 51-53 36-54 40-59 49-57 42-51 Cash dividends 1.560 1.430 1.300 1.202 1.137 Work Cited Calculate and Interpret the Cost of Equity. Stock Research Pro. 2009. Web. 16 June 2011. Hsu, H Christine. Using Dow Jones Interactive to Perform Financial Ratio Analysis. California State University. 1999. Web. 16 June 2011. Little, Ken. Understanding Price to Earnings Ratio. About.com. 2011. Web. 16 June 2011. < http://stocks.about.com/od/evaluatingstocks/a/pe.htm> Thomsett, Michael C. J. K. Lasser’s Buy, Sell, or Hold: Manage Your Portfolio for Maximum Gain. John Wiley & Sons, Inc. 2002. Web. 16 June 2011. Read More