Wall Street loves a growth story, which is basically why Kellogg decided to break itself up into Kellanova (K 0.07%) and WK Kellogg (KLG -1.81%). But there's a problem with this business move that just doesn't make sense to me.
So I sold virtually all of my position before the transaction was completed. Here's why.
Kellanova will probably live up to expectations
Prior to the recent spinoff of WK Kellogg, the iconic food maker had been shifting out of slower-growth businesses (Keebler) and into faster-growing ones (Pringles). It was a good direction for the company to move in. The story was basically that Kellogg had a foundation in the cereal business, on top of which it was building a faster-growing snacking operation.
Image source: Getty Images.
Cereal is not a great food product to sell in North America. The heyday of the breakfast staple is long past as consumer eating habits have changed. The mature sector is driven by a competitive fight for market share.
A fire at a cereal plant and an employee strike, both in 2021, contributed to Kellogg brands losing a notable amount of market share in recent years. The cereal business became a drag on the overall company, at least in North America. Even gaining back market share, which the WK Kellogg company is in a position to do now that its challenges are in the rearview mirror, will only achieve so much for the business over the long term.
After recovering market share, though, the story gets pretty dismal again. WK Kellogg will have to focus on cost savings to boost results via margin expansion at a time when inflation is running hot -- not an easy task. Assuming WK Kellogg management can increase margins, the next problem is what happens after that. Its only options are to either expand via acquisition or geographically.
But WK Kellogg only owns the Kellogg cereal brands in North America. Kellanova is still selling the iconic cereal brands in the rest of the world -- areas where the cereal sector is actually still growing, for the most part. So this split has left WK Kellogg with a bad hand. Note that a relatively small cereal company will be at a competitive disadvantage when it comes to acquisitions, as it competes with much larger consumer staples companies, including its former parent Kellanova.
The Kellanova story is odd, too
Because of those issues, I don't want to have a big position in WK Kellogg. (I still own a handful of shares in Kellanova and WK Kellogg, basically to keep up on the story as it develops.) At the same time, I have no doubt that Kellanova will be able to grow more quickly without the drag of the North American cereal business. But the two companies are tied at the hip because Kellanova sells the same brands internationally.
This is an odd tie-up. If WK Kellogg falters, there could be brand damage that would hurt the image of Kellanova's international cereal business. And then there's Rice Krispies Treats. This snack business went with Kellanova, even though Rice Krispies is being sold by WK Kellogg in North America. There's a very direct link even in the North American market when it comes to the Rice Krispies brand.
This all seems like something of an accounting game to make Kellanova look more attractive to investors. Given some time it will probably work, but there are too many lingering ties for me to want to own a material position in Kellanova. There are other publicly traded food makers without undesirable attachments.
Too complicated for my taste
When I step back and look at the big picture, this spinoff hasn't simplified the business; it's become more complicated, and not in a good way. It's hard enough to keep track of a portfolio of investments without having to deal with the odd business connections that will still exist between Kellanova and WK Kellogg.
As for WK Kellogg, it isn't particularly desirable to own a disadvantaged business in a difficult industry niche. All in all, I'm happy to have basically stepped away from this story, now that the story has materially changed.
