If early returns are any indication, it looks like the nearly $3 billion deal for Pringles is going to work out for Kellogg (NYSE:K). Management has already indicated, through SEC filings and this quarterly report, that the deal is looking even more accretive than originally expected, and it looks like the cereal business is also improving. The biggest question with Kellogg would seem to be whether the company can deliver real growth at the operating/EBITDA line, but today's valuation already seems to expect solid improvements there.

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Good, but not Perfect Third Quarter Numbers
Kellogg reported one of those Rorschach quarters - bullish investors will see a lot to like, while bears will see enough to maintain their skepticism. While reported growth looks solid, underlying/internal performance is still problematic.

Revenue rose more than 12% as reported (slightly better than expected), but internal sales growth was less than 3% (with only a tiny improvement in volume). Sales were up about 4% in North America on an organic basis, while international sales rose only 1% on a similar basis.

Profits were likewise mixed. Gross margin fell about two points on a GAAP basis, while reported operating income rose just 3%. More troubling was the company's data pointing toward a 5% decline in "internal" operating profits; the Mini-Wheats recall no doubt led to some elevated costs, but internal operating profit growth continues to be unimpressive here.

SEE: How To Decode A Company's Earnings Reports

Cereal Back to Snap, Crackle and Pop?
With U.S. cereal sales up 5% this quarter, it's worth asking whether Kellogg's efforts to better manage inventory and innovation are already paying off. Nielsen data can be tricky on a month-to-month basis, but it does look like Kellogg is back to outgrowing Post (NYSE:POST) and General Mills (NYSE:GIS) and is doing quite well with more "innovative" new products. At the same time, long-term investors know better than to get too excited about one or two quarters, so this would still appear to be a "stay tuned" category for Kellogg.

Pringles off to a Good Start
Pringles is already making an impact on sales and profits at Kellogg; of the 12.3% reported sales growth, 11.3% of it was from Pringles, and the acquisition likewise had a positive impact on profits. Perhaps even more importantly, recent SEC filings from Kellogg would seem to point to substantially better accretion potential from the deal over the next couple of years. Now while some of this seems to be more of an accounting phenomenon (less amortization and so on), it nevertheless seems that the acquisition is off to a good start for Kellogg.

SEE: The Wonderful World Of Mergers

Growth Still a Big Question Mark
If you look at the operating income (or EBITDA) growth that Kellogg has produced over the past decade, it just doesn't look all that impressive. Now, this isn't an uncommon problem and companies such as Campbell Soup (NYSE:CPB), Heinz (NYSE:HNZ) and ConAgra (NYSE:CAG) have the same issue, but it's still worth asking whether investors should pay a double-digit EV/EBITDA multiple for a company that looks hard-pressed to deliver growth beyond the 3%-4% range.

There are definitely opportunities for Kellogg to post better growth. The company is an underperformer on the global packaged foods stage, and if it can maintain its momentum with product innovation (and extend it beyond cereal) that too could add growth. Last and not least, Kellogg has seemingly had more supply chain issues than other large food companies, and tightening this up could offer a path to better reported results. Still, investors considering these shares shouldn't ignore that growth issue.

The Bottom Line
Kellogg is popular enough with institutions that it doesn't get, or stay, cheap all that often. While this stock has not been a scintillating performer this year, it has more or less kept pace with its peers. Assuming that the company has good news for investors at the upcoming analyst meeting, I wouldn't be surprised to see the multiple stretch even a little more.

On a cash flow basis, the shares don't look all that cheap. Even high single-digit projected cash flow growth doesn't push the fair value more than 10% above today's price, and Kellogg would have to deliver some surprising outperformance on either revenue growth or free cash flow conversion to support a higher growth target. Consequently, Kellogg continues to look like a good hold, but investors putting new money to work today shouldn't expect these shares to dramatically outperform the market over the next few years from today's starting point.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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