General Mills – Can Product Diversification Meet Financial Recovery Expectations?

General Mills is a leading global manufacturer and marketer of branded consumer foods sold through retail stores. The company is a leading supplier of branded and unbranded food products to the North American foodservice and commercial baking industries. After the acquisition of Blue Buffalo in fiscal 2018, General Mills is providing manufacturing and marketing operations in the wholesome natural pet food category. The company produces its products in 13 countries and markets them in more than 100 countries.

General Mills offers a variety of food products for consumers around the world, with six large global segments: snacks, ready-to-eat cereal, convenient meals (pizza, soup, frozen meals, ethnic meals), yogurt, pet food, and premium ice cream. The company’s other product categories include baking mixes and ingredients, and refrigerated and frozen dough. As of May 27, 2018, General Mills had approximately 40,000 employees around the world. 

Overview

Haagen-Dazs, Yoplait, Nature Valley, Cheerios, Betty Crocker, Old El Paso, Colombo, and Lucky Charms are some of the pronounced brands in the company’s product range. According to Morningstar, General Mills has 17% of revenue and 30% market share from ready-to-eat cereal food category, and the company owns three of the top five brands in the United States. General Mills has 15% of revenue and 18% market share from the yogurt category. The company is one of the industry giants; however, it is under pressure from changing consumer tastes, niche brands and easy to reach e-commerce opportunities for households. The company’s snacks and cereal sales growth are flat in North America comparing to 2017 fiscal period. General Mills’ yogurt sales decline is more than 10% in North America due to increased competition.  

The company acquired Blue Buffalo for USD 8 billion with a combination of USD 6 billion in debt, USD 1 billion in equity, and cash on hand in April 2018. Blue Buffalo revenue increased from USD 200 million to USD 1.3 billion between 2010 and 2017. We expect that the acquisition of Blue Buffalo helps to take advantage of a “humanization of pets” trend have supported by 5% annual growth for pet food sales. General Mills may use its current distribution network, supply chain, and customer listings, which will make Blue Buffalo product range more reachable and reduce the overall cost of goods sold, operating expenses. 

The company stepped up cost-cutting efforts and reduces promotions, announced General Mills is laying off 625 positions by the end of 2019. Chief Financial Officer Don Mulligan said in an interview that “this is part of our resource agility. At the same time that these positions may be being reduced, we are adding roles in growth areas.” He pointed to its Asia, e-commerce, and data-analytics businesses.

We expect that the acquisition of Blue Buffalo helps to take advantage of a “humanization of pets” trend have supported by 5% annual growth for pet food sales. General Mills may use its current distribution network, supply chain, and customer listings, which will make Blue Buffalo product range more reachable and reduce the overall cost of goods sold, operating expenses.  The company stepped up cost-cutting efforts and reduces promotions, announced General Mills is laying off 625 positions by the end of 2019.

Investment Characteristics

The company has a relatively stable revenue stream, which is 1.43% annual-average, after analyzing the 10-year annual financial periods. General Mills has contracted gross margin to below 34% in the August 2018 quarterly financial statements. Its gross margin is also relatively stable between 35% range in the 10-year period. The recent period’s declining profit margin is due to one-time purchase accounting related to the Blue Buffalo acquisition. The quarterly report of the company mentioned higher input costs, including currency-driven inflation on imported products in certain markets affected the profitability.

The company’s operating profit margin is 14.66%, which indicates approximately 1.3% decrease. However, its net sales increased by 9% to USD 4.1 billion. The component of organic sales growth suggests that sales volume is declined by 1%, but the net price increase of 1% balanced the flat sales growth. General Mills’ sales growth is due to the Blue Buffalo acquisition. The company’s relatively small penetration geographical areas of Latin America/Asia indicate sales increases of 2%, but the dominant segment of North America is decreased by 2%. The company explains North America retail segment sales decline with co-packing sales related to the North American Green Giant divestiture, and 4% sales decline in the US snacks operating units and 2% each in US meals & baking and US yogurt. However, the company’s management mentions that independent metrics indicate that market share is increasing in 8 of the segment’s 9 largest U.S. categories due to matching consumer preferences and positioning in the natural and organics category.

General Mills has USD 3.2 billion of negative working capital due to the acquisition-related increased debt levels. Its cash conversion ratio also directs that its accounts payable levels are piling up. These ratios show that the company attempts to stabilize its operating cash flows in the near future.

The component of organic sales growth suggests that sales volume is declined by 1%, but the net price increase of 1% balanced the flat sales growth. General Mills has USD 3.2 billion of negative working capital due to the acquisition-related increased debt levels. Its cash conversion ratio also directs that its accounts payable levels are piling up.

Valuation

Our fair value estimate for General Mills is USD 55 per share. We categorize the company as large-cap and value investment. The company’s industry is consumer defensive. General Mills share prices increased during the 2008 economic crisis; however, during bull markets, the share prices do not outperform the main indices. We estimate the growth rate of revenue is 1.5% to 2% in the next five-year period. After these periods, we assess the long-term growth rate in 1% range. The company’s recent acquisition of Blue Buffalo is expected to increase its product diversification in organics and natural segment, according to shifting consumer preferences. General Mills also has well-established products and steep market share in the cereal, frozen meals, yogurt categories. The company and its predecessor firm have paid dividends without interruption for 119 years. This historic figure represents stability and attracts dividend investors regarding future dividend payments. The company’s increased competition in retailers and retailers’ negotiation and price powers deteriorate center store dominance in the current period. General Mills has efforts in organic and foods, which may slightly edge towards its competitors and increase growth momentum. We expect the company’s cost of goods sold and operating expenses to around 76% of its revenue in the near future. In our analysis, we project the modest decline in operating expenses due to the company’s cost-saving initiatives. An estimated enterprise-value-to-sales ratio is 6.87, and an enterprise-value-to-EBIT ratio is 19.24 in our analysis.

Risks to consider

The consumers tend to change their consumption behavior to fresh and organic foods. General Mills has increased burden related to its packaged foods and consumer expectations. The company’s diminished market shares of yogurt and convenient meals, and expanded promotional activities of these industries support our findings. The niche organic and private-label brands induce cost competition and brand investment dilemma. General Mills may not be able to reflect raw material costs to consumers. One supporting example indicates overall volume decline, but the price increase of its products in the company’s recent quarterly report. We expect Blue Buffalo to increase General Mills’ overall margins and create synergies and supply chain optimization. The investors need to consider the integration risk of the acquired company and unanticipated difficulties in the pet food sector. Also, the increased leverage and the diminished working capital of the company are two of the risky financial health indicators. 

The niche organic and private-label brands induce cost competition and brand investment dilemma. General Mills may not be able to reflect raw material costs to consumers. We expect Blue Buffalo to increase General Mills’ overall margins and create synergies and supply chain optimization.

Other considerations

The company’s historical growth rates indicate the industry focus as a defensive and non-cyclical consumer. General Mills’ stable dividend payments also support consistency and stability. The average 10-year dividend payout ratio is approximately 55%. Jeff Harmening was appointed as CEO in 2017. Mr. Harmening joined General Mills in 1994 and has served in a variety of positions, most recently COO. According to 2018 annual report, Mr. Harmening’s compensation package surged from USD 4.6 million to approximately USD 8 million. His base salary seems to be in line with previous CEO’s 3-year average, and still USD 1.2 million less than previous CEO’s compensation of last year. However, USD 3 million stock awards, USD 1.7 million option awards and USD 1.2 million non-equity incentives indicate more than USD 3 million increase in his compensation.

We consider recent Blue Buffalo acquisition is strategically important due to the importance of adapting changing consumer expectations and demands. However, investors need to carefully consider the return generation abilities of the company’s investments in natural and organic foods for niche brands. 

Conclusion

General Mills Stock Movements 092018
Source: tradingview.com

The company’s stock price is near 52-week lows, and its price-to-earnings ratio is at the 3-year lows. General Mills’ dominance of various domestic food categories has helped the company’s financial metrics even in the 2008 financial crisis. For stability-lover investors and dividend followers, the company meets expectations. However, the company’s stagnant revenue growth, profitability ratios, declining market shares to niche natural brand competitors indicates a red flag to be aware of. The company’s recent acquisitions and investments may help to launch new or rebranded products to adopt the changing consumer environment.  

Disclosure: I do not have any of the securities mentioned above. This article expresses my own views, and I wrote the article by myself. I am not receiving compensation for it. I have no business relationship with any company whose security is mentioned in this article.

Image Source: General Mills Website

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Covers investment, financial analysis and related financial market issues for BrightHedge. He has extensive experience in portfolio management, business consulting, risk management, and accounting areas.

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The investment information, comments and recommendations contained herein are not subject to investment advice. The comments and recommendations contained herein are based on personal views. These views may not fit your financial situation and your risk and return preferences. For this reason, based only on the information contained herein, investment decisions may not have the appropriate outcome.