Kellogg’s Diagnosed Lactose Intolerant – Stock Ulcerates, Suffers Gastric Event! (K)

On the fourth of August, Kellogg Co. (NYSE:K) announced earnings and all was well at the breakfast table.

Earnings beat.

Sales Beat.

But ever since, the stock has done precious little – albeit in a tough market – and it now appears a top may be forming.

An All-American Top

Kellogg’s is splitting itself into three separate businesses, and getting out of the slow-growth cereal trade – opting instead to become a snack food enterprise, a move it’s been careening toward for a while now.

With Special K out and PopTarts and Pringles in, Kellogg’s hopes to capture a bigger share of the fast-growing, junk food sector – a decision we believe they’ll live to regret.

Why?

Because harder times are headed our way, and simply put, folks will choose staples over snacks when resources are scarce: that means Corn Flakes and All Bran before CHEEZ-IT.

Inflation is already starting to take a bite out of earnings, and we expect there’ll be significant push-back on the part of consumers when the company tries to pass price increases through to shoppers this fall.

At that point, Kellogg’s may find itself toothless and wishing it had stuck with its core business.

Fundamentals

Let’s look at some numbers…

• P/E for the stock is 17.04 – reasonable relative to the rest of the market.
• Dividend Yield is 3.20% – outright rich compared the S&P 500, but again, this is the fate of a mature company whose growth prospects are limited, and reinvestment is less an option that returning cash directly to investors.
• P/B is too high at 6.13,
• Debt/Equity is too high at 1.72, and…
• Analyst recommendations are now, on average – HOLD.
• Why?  Not sure, but it likely has something to do with the 2.30% annual growth rate those same analysts see, on average, over the next five years.  In other words, we’ve plateaued.  And in the investment world that means… it’s time to buy a net.
• Oh, and insiders sold $120 million worth of stock over the last six months.

Here’s a chart for those same six months –

Technically, we’re looking at…

1. An overbought RSI read mid-April (circled, in red) that led to…
2. Negative divergence from both RSI and MACD (green arrows).  That’s a widely accepted sign that bullish momentum is on the wane.
3. RSI has now passed below its mid-way waterline (green box), and we await confirmation from MACD, at which point we expect to see an avalanche of selling.  NOTE: that could still be up to a week away.
4. Volumes have been contracting as we came to the latest top (in black), and that points to a lack of bullish commitment.
5. Last Friday’s price action broke below the short-term MA (in purple), meaning next support is 73.
6. Beyond that, Fibonacci calculations prefigure a decline to 71 and possibly 66.50.
7. After a 30% jump in price (from a stodgy, old, milk-sopped business like this), we believe a decline is all but guaranteed.

But it doesn’t have to be dramatic.

In fact, we could cash in fully – to the tune of 1567% – with no cash layout on the trade on a rather meagre decline!

Check it out –

A Jew and His Money recommends you consider selling the K December 16^th 72.50/75 CALL spread* for a credit of $1.05 (4.00/2.95) and buying the K December 16^th 72.50/70 PUT spread** for the same $1.05 (3.20/2.15).  Net Zero premium is the result.

[*Sell the 72.50 CALL and buy the 75 CALL.  **Buy the 72.50 PUT and sell the 70 PUT.]

Rationale: we like not having to pay for the trade.

We also like the ensuing payoff: accounting for minimal commissions gives us a max gain of 1567%.

Max loss is $2.50 (difference between the short CALL strikes).

Breakeven comes at $72.50, just 1.8% below the current price.

And a 5% decline gives us all the PopTarts we could ever yearn for.

HaKadosh Baruch Hu operates the toaster, fellow diners.

May He grant all ye good Jews and Noahides a sweet – and nutritious – return.

With kind regards,

Hugh L. O’Haynew

Follow @HughLOHaynew