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Kellogg Co (NYSE:K)
Earnings Power Value (EPV)
$22.00 (As of Dec16)

As of Dec16, Kellogg Co's earnings power value is $22.00.

Margin of Safety is -231.89%.

The basic concept of EPV is that one should value a stock based on the current free cash flow of a company and not on future projections which may, or may not, come true. It is arguably a better way to analyze stocks than Discounted Cash Flow analysis that relies on highly speculative growth assumptions many years into the future. Assumption: Current profitability is sustainable.


Definition

Earnings Power Value also known as just Earnings Power is a valuation technique popularised by Bruce Greenwald, an authority on value investing at Columbia University. It is arguably a better way to analyze stocks than Discounted Cash Flow analysis that relies on highly speculative growth assumptions many years into the future.

The basic concept of EPV is that one should value a stock based on the current free cash flow of a company and not on future projections which may, or may not, come true. This valuation tool excludes the potential growth that a company may have so that needs to be looked at separately. Since future growth is excluded from the analysis, only the maintenance capital expenditures are subtracted from after-tax EBIT (earnings before interest and taxes) and growth capex is ignored.

Kellogg Co's "Earning Power" Calculation:

Average of Last 20 QuartersLast Quarter
Revenue 14,022
DDA 507
Operating Margin % 11.15
SGA * 25% 906
Tax Rate % 26.67
Maintenance Capex 504
Cash and Cash Equivalents 280
Short-Term Debt 1,069
Long-Term Debt 6,698
Shares Outstanding (Diluted) 354

1. Start with "Earnings" not including accounting adjustments (one-time charges not excluded unless policy has changed). "Earnings" are "Operating earnings" (EBIT).

2. Look at average margins over a business/Industry cycle: Average Operating Margin = 11.1465%

To normalize margins and eliminate the effects on profitability of valuing the firm at different points in the business cycle, it is usually best to take a long-term average of operating margins. Ideally this would be as long as 10 years and include at least one economic downturn. However, since most of companies do not have as long as 10-year history, here GuruFocus uses the latest 5 years data to do the calculation. To smooth out unusual years but reflect recent developments, we take an average of the 5 year margin.

3. Multiply average margins by sustainable revenues and then adjust for maintenance SGA. This yields "normalized" EBIT:

To be conservative, GuruFocus uses an average of the 5 year revenues as the sustainable revenue.
EPV analysis recognises that part of SG&A expenditure is made to maintain and replace the existing assets, while part is made to grow sales. Since EPV is only interested in what it costs a going concern to maintain its existing asset base, it adds back a percentage of SG&A (between 15% and 50% - this is a matter of judgment and industry knowledge) to make up for the fact that some of this expenditure went to fund growth and shouldn't be accounted for. To start off, we assume 25% for the sake of prudence.
Sustainable Revenue = $14021.6 Mil, Average Operating Margin = 11.1465%, Average Adjusted SGA = 906.35,
therefore "Normalized" EBIT = Sustainable Revenue * Average Operating Margin + Average Adjusted SGA = 14021.6 * 11.1465% +906.35 = $2469.267644 Mil.

4. Multiply by one minus Average Tax Rate (NOPAT):

Same as average operating margin calculation, GuruFocus takes an average of the 5 years tax rates.
Average Tax Rate = 26.669%, and "Normalized" EBIT = $2469.267644 Mil,
therefore After-tax "Normalized" EBIT = "Normalized" EBIT * ( 1 - Average Tax Rate ) = 2469.267644 * ( 1 - 26.669% ) = $1810.73865602 Mil.

5. Add back Excess Depreciation (after tax at 1/2 average tax rate). This yields "normalized" Earnings:

Excess Depreciation = Average DDA * % of Excess Depreciation (after tax at 1/2 average tax rate) = 506.8 * 0.5 * 26.669% = $67.579246 Mil.
"Normalized" Earnings = After-tax "Normalized" EBIT + Excess Depreciation = 1810.73865602 + 67.579246 = $1878.31790202 Mil.

6. Adjusted for Maintenance Capital Expenditure:

First, calculate the revenue change regarding to the previous year. If the revenue decreased from the previous year, then the Maintenance Capital Expenditure = Capital Expenditure (positive).
Second, if the revenue increased from the previous year, then calculate the percentage of Net PPE as of corresponding Revenue.
Third, calculate Capital Expenditure (positive) - percentage of Net PPE as of corresponding Revenue * revenue increase.
If [Capital Expenditure (positive) - percentage of Net PPE as of corresponding Revenue * revenue increase] was negative, then the Maintenance Capital Expenditure = Capital Expenditure (positive).
If [Capital Expenditure (positive) - percentage of Net PPE as of corresponding Revenue * revenue increase] was positive, then the Maintenance Capital Expenditure = Capital Expenditure (positive) - percentage of Net PPE as of corresponding Revenue * revenue increase.
Fourth, GuruFocus uses an average of the 5 year maintenance capital expenditures as maintenance CAPEX.
Kellogg Co's Average Maintenance CAPEX = $503.7117 Mil

7. Investors require a return of "WACC" for the risk they are taking: WACC = 9%

8. Kellogg Co's current cash and cash equivalent = $280 Mil.
Kellogg Co's current interest bearing debt = Long-Term Debt + Short-Term Debt = 6698 + 1069 = $7767 Mil.
Kellogg Co's current diluted shares outstanding = 354.000 Mil.

Kellogg Co's Earnings Power Value (EPV) for Dec16 is calculated as:

EPV=( ( Norm. Earnings-Maint. CAPEX )/WACC+CashandEquiv-Int. Bearing Debt )/Shares Outstanding
=( ( 1878.31790202-503.7117 )/9%+280-7767 )/354.000
=22.00

Margin of Safety (EPV)=( Earnings Power Value (EPV)-Current Price )/Earnings Power Value (EPV)
=( 21.9954865669-73.00 )/21.9954865669
=-231.89 %

* All numbers are in millions except for per share data and ratio. All numbers are in their local exchange's currency.


Explanation

Assumption: Current profitability is sustainable.

Earnings power value (EPV) uses a very basic equation which assumes no growth, although it does rely on an assumption about the cost of capital as well as the fact that current earnings are sustainable. It also involves several adjustments to clean up the underlying Earnings figures.


Be Aware

Though using today's earnings in calculating Earnings Power Value, GuruFocus is normalizing these earnings to the business cycle. This eliminates the effects on profitability of valuing the firm at different points in the business cycle. This means that we are considering the average earnings over 5 years.


Related Terms

Revenue, DDA, operatingmargin, SGA, Net PPE, Cash Flow_CPEX, Short-Term Debt, Long-Term Debt, Shares Outstanding


Historical Data

* All numbers are in millions except for per share data and ratio. All numbers are in their local exchange's currency.

Kellogg Co Annual Data

Dec07Dec08Dec09Dec10Dec11Dec12Dec13Dec14Dec15Dec16
EPV 26.5029.9034.4334.0533.4226.7028.5024.1817.3622.00

Kellogg Co Quarterly Data

Sep14Dec14Mar15Jun15Sep15Dec15Mar16Jun16Sep16Dec16
EPV 27.2924.1821.7121.9619.6517.3615.9916.6417.2022.00
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