This Company Spinoff Is More Than Just News – It’s an Investing Clue

By TradeSmith Editorial Staff

Listen to this post
At the start of “The Big Short,” the narrator shares that a few individuals knew we were headed toward a real estate collapse in the mid-2000s.

He says that while the world was having a big party, a few “outsiders and weirdos” saw what was going to happen because they did something “the rest of the suckers never thought to do.”

“They looked.”

Although that quote was in reference to the real estate bubble, it reminds me of company spinoffs and how investors aren’t taught how to “look” at them.

A spinoff is when a company creates a new independent company with the idea being that certain segments of a business can perform better — operationally and financially — when they are not tethered together under one umbrella.

For instance, Abbott Laboratories (ABT) spun off AbbVie Inc. (ABBV) back in 2013 so that Abbott could focus more on selling medical devices, diagnostics, branded generic pharmaceuticals, and nutritional products.

AbbVie was to focus on a portfolio of drugs, which included the blockbuster medicine Humira.

In the chart below, you can see that spinoff has paid off for shareholders of both companies over the past five years, with ABT and ABBV each outperforming the S&P 500.

Source: Google Finance

And for a more general overview, Deloitte and Edge Consulting Group found that between 2000 and 2014, spinoff stocks generated a 22% return in the first 12 months of trading. That’s even better than the 14% return of the parent company that performed the spinoff.

Not all spinoffs will work out, but the data above shows that any time one happens, it’s a profit opportunity.

While this sounds like an area of investing most people would jump on, they generally don’t.

Companies doing the spinoffs don’t offer a lot of communication behind what’s happening, index funds often can’t hold the new company’s stock and sell it if they receive it as a part of the spinoff, and some analysts even stop following the stock because they don’t know how to value it anymore.

This all boils down to the fact that investors simply aren’t provided enough guidance on how to look at these opportunities.

That’s why I want to show you how to evaluate Kellogg Co. (K) as it plans to spin off its business into three segments.

Spinning Three Ways

On June 21, 2022, Kellogg announced plans to split itself into three independent entities, with the transactions expected to be completed by the end of 2023.

The official names have not been decided on, but they are being referred to as Global Snacking Co., North American Cereal Co., and Plant Co.

The snacking division includes products like Pop-Tarts and Pringles, the cereal division includes products like Rice Krispies and Raisin Bran, and the plant-based food division will feature the MorningStar Farms brand.

“These businesses all have significant standalone potential, and an enhanced focus will enable them to better direct their resources toward their distinct strategic priorities,” said CEO Steve Cahillane.

That sounds nice, but let’s unpack what’s going on with each division.

In 2021, Kellogg generated net sales of $14.2 billion.

Of that $14.2 billion:

  • $11.4 was generated from snacking.
  • $2.4 billion was generated from cereal.
  • $340 million was generated from plant-based foods.
With snacking being the largest revenue generator, it’s encouraging to consider that this business unit will be even more focused on doing what it does best.

The cereal unit isn’t as promising.

Cereal sales climbed nearly 9% in 2020 as more people were stuck at home because of COVID-19, but the trend before that was not good. Cereal sales dropped in both 2018 and 2019 as people began looking for healthier options and foods that work to take on the go.

With fewer people eating breakfast at home as they return to offices and their pre-pandemic activities, it’s going to be difficult for any company in the cereal industry to keep up its momentum.

As for the plant-based food business, it has been an insignificant revenue driver for Kellogg Co. compared to the snack and cereal divisions. But the company has said that it’s open to selling the plant-based food business.

The global plant-based food market is projected to grow from an estimated value of $40.21 billion in 2021 to $78.95 billion by 2028, so this spinoff from Kellogg Co. could receive a premium offer.

How to Invest

When this spinoff takes place, shareholders of Kellogg Co. (K) will receive shares of the new companies (cereal and plant-based foods) on a pro-rata basis based on their holdings of Kellogg stock.

Right now, our system says that K is a “Buy”: It’s in our Green Zone, has a medium-risk Volatility Quotient (VQ) of 16.64%, and pays a dividend with a yield of more than 3%.

The stock prices for the two spinoff companies, however, might not have a great start out of the gate.

Shareholders may just sell their positions in these new companies as soon as they can because they don’t understand the new business, or because they decide that it doesn’t fit into their investment criteria.

If the stock price for the plant-based food business drops initially, it could be a speculative, long-term profit opportunity to buy more shares, as that is a company that could be acquired with a potential premium payout.

That potentially bullish outcome could be less likely for the cereal business, considering more consumers are focused on healthy eating and portable food choices for breakfast. But keep in mind that the cereal unit still generated over $2 billion in sales last year, and operating on its own could unlock more opportunity over the long term.

As more details are presented and the spinoff approaches, our team will follow up on this story to help you navigate everything that’s happening.