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WALL STREET, CALIFORNIA | Stock Exchange / James Peltz
and Michael Hiltzik

Soggy Kellogg Is a Bad Bet; Is Starbucks Too Strong?

November 10, 1998|JAMES PELTZ and MICHAEL HILTZIK

Stock Exchange gives readers a chance to listen in as staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks and other investments.

Kellogg Co. (K)

Jim: I guess we have a breakfast theme today, Mike, since we're looking at Kellogg and Starbucks.

Mike: That's right, a bowl of cold cereal and a cup of joe--it doesn't get any better than this. Actually, Kellogg probably ranks among the Big Board's leaders in terms of the catch phrases it's given to the English language.

Jim: Such as?

Mike: "Snap, crackle and pop." "They're grrrreat!" "Two scoops." Sadly, though, Kellogg itself is down to about a half-scoop these days.

Jim: Yeah, it's pretty ugly in Battle Creek. Kellogg is still the nation's largest maker of ready-to-eat cereal, and its big names include Kellogg's Corn Flakes, Frosted Flakes and Rice Krispies.

Mike: But its share of the market has plummeted to about 32% today from 41% a decade ago.

Jim: And to me, the reason is pretty simple: Kellogg and other brand-name cereal makers went to the well once too often in terms of jacking up prices.

Mike: That's right. Up to a couple of years ago, it was supermarket sticker shock. The price of a box of cold cereal got as high as $4 and $5 a box, and consumers rebelled.

Jim: Naturally. Shoppers got fed up with such high prices for what's basically a staple product. They started buying cheaper, generic brands of cereal.

Mike: What's often called bagged cereal.

Jim: Right--those less costly knockoffs produced by the likes of Quaker Oats Co. and Ralcorp Holdings Inc. Or they stopped buying cereal altogether. Those high prices, combined with the increasingly hurried lifestyles we all have, prompted more and more people to buy fruit bars or granola bars or other take-it-with-you snacks.

Mike: Not to mention the people who stopped buying cereal because they're sensitive to what's actually in a bowl of cereal.

Jim: True. And all these factors mean the whole cereal market is shrinking, making Kellogg's problems even worse.

Mike: There's a reason the cereal companies became master marketeers. Kellogg was selling either pure sugar or so-called nutritious cereals that tasted like new-and-improved forms of cardboard.

Jim: And they're at it again. Last week, Kellogg announced its new "Ensemble" line of foods, including cold cereal, that have natural soluble fibers in them that purportedly help to lower your cholesterol. But this is all noise anyway. The central problem is, Kellogg hasn't figured out how to stop the bleeding. They could wage an all-out price war to boost their market share ...

Mike: ... but then could kiss their profit margins goodbye.

Jim: And watch their stock take a beating. Or Kellogg can try to hold prices, but that means they'll have to cut costs even further--especially since they have to keep spending a fortune advertising these brands--and I haven't seen signs they're going to do that. So where's the light at the end of the tunnel? That's why I can't recommend this stock.

Mike: Me neither. Kellogg in the last couple of years has made lots of promises to investors that it's going to turn this ship around but hasn't delivered. So even if Kellogg comes up with a solution, there's going to be skepticism built into this stock for quite a while.

Jim: That's evident in the stock's price. It's now in the mid-30s, which is down 20% over the past 12 months. But that's nothing. In the past five years, the Standard & Poor's 500 has risen 137%. Care to guess Kellogg's gain?

Mike: I'm sure it's a soggy reflection of the S&P.

Jim: It's 9%. That's pathetic for a company that has household brand names and leads its industry.

Starbucks Corp. (SBUX)

Jim: Can you explain to me, Mike, what Starbucks puts in its coffee that convinces people to keep coming back to pay $2 or more per cup? Is it nicotine? I read somewhere that the average Starbucks customer visits that place 15 to 17 times a month.

Mike: Is that all? Actually, there are a lot of numbers about this company that strain credulity, although I'm not saying they're not true.

Jim: Nice double negative. But you're right.

Mike: As for the stock, I've always been troubled by its price-to-earnings multiple, which usually seems to be out of sight. So you might be surprised to hear that I've come around.

Jim: You'd recommend it? The caffeine has gone to your head. I'd avoid this stock, mainly because of that very P/E you mention.

Mike: Hear me out. Starbucks is an amazing company that still has a long way to go in fully developing its brand. Already it's expanded its brand name in new and fascinating ways and, up to now, most of what it's tried has worked.

Jim: Here are the basics: The company, led by Chief Executive Howard Schultz, went public at a split-adjusted $4.25 a share in '92, and the company and the stock have skyrocketed ever since, with the stock having soared tenfold since then. Starbucks now has around 1,930 outlets, including a couple hundred overseas, and they're still hungry to expand.

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