General Mills: Still A Tough Place

Over the summer, I believed that General Mills (NYSE:GIS) was facing underlying volume challenges as inflationary trends translated into solid reported financial numbers, but weaker underlying trends.

The same trends were seen in the first quarter of the fiscal year 2024 as this observation and prospects for weaker growth and demand for its products have caused another re-rating in the stock, as interest rates moved higher as well.

Given all this, I am still very cautious on the shares here, although that the stronger brands in the industry likely present interesting long term entry opportunities here.

A Food Conglomerate

Pre-pandemic, General Mills was a $17 billion food business with particular strength in cereal, yogurts, snack & meals as well as dough & backing mixes. An $8 billion deal for Blue Buffalo furthermore added animal foods as a stronghold to its business line-up. Most of these sales were generated in North America, complemented by operations in Europe and Asia.

The deal for Blue Buffalo saddled the business with a substantial net debt load of $13.0 billion, certainly in relation to a $3.6 billion EBITDA number, with leverage reported near 4 times. Adjusted earnings of $3.20 per share worked down to a modest 15 times earnings multiple, with shares trading in the mid-forties.

Since the start of the pandemic, shares have gradually risen from the higher forties to the $70 mark, as the company made some small tweaks to its product portfolio, adding small businesses, while divesting some other non-core assets.

All this made that the company showed some improvements as the company reported its fiscal 2022 results in the summer of 2022. Full year revenues had advanced to $19 billion, with adjusted earnings up to $3.94 per share, in part because net debt was down to $11.0 billion. The outlook for the fiscal year 2023, with organic sales seen up 4-5% and adjusted earnings per share seen up 3%, was less convincing, certainly considering the inflationary environment in which we find ourselves.

By June of this year, the company posted a 6% increase in full year sales to $20.1 billion, with growth held back by some divestments. Adjusted earnings rose by 9% to $4.30 per share, as net debt of $11.1 billion was manageable given an EBITDA number of $4.0 billion.

Under the hood, the composition of growth was quite poor with pricing and mix effects being up as much as 15%, in part offset by an 8% decline in volumes, which is a serious decline. The company guided for fiscal 2024 organic sales seen up 3-4%, with earnings per share seen up 4-6%. I actually saw risks to the guidance as consumer food businesses were facing disinflationary pressures, on top of which volume declines were reported.

With the business trading at 17-18 times earnings, while leverage was under control, appeal was improving as shares were down from a high around $90 per share to levels in the seventies. This made that I was only considering an allocation in the sixties.

Coming Down Further

Since July, shares have fallen from the mid-seventies to current lows around $64 per share. Towards the end of September, General Mills posted a 4% increase in first quarter sales to $4.9 billion. Both pricing and volume trends moderated, with prices/mix still up 6% (being less inflationary than before) as volume trends improved to 2% declines. This naturally causes pressure on margins, with adjusted earnings per share down two pennies to $1.09 per share.

Net debt rose to $11.8 billion, increasing a bit on a sequential basis due to higher dividends and some share buybacks, in fact half a billion worth of shares were bought back in the past quarter. On the bright side, adjusted EBITDA likely tops $4 billion per annum here.

The company reconfirmed the full year guidance in terms of (organic) sales growth and earnings per share, but it seems that there are some risks to the topline sales numbers, as the company might rely more heavily on share buybacks to deliver on its earnings per share targets.

This is reflected in the share price which is down about 15% since the summer, as in fact at $64 per share, the multiple has compressed to 16 times based on earnings power of $4 per share, although that earnings might top this number this year.

And Now?

The reality is that the share price shortfall since the summer is likely greater than the somewhat softer first quarter results. The company is plagued by a combination of lower volumes and moderating inflation, as demand for big brands is on the decline, with consumers opting for store brands en masse.

The lower share price pushed up the dividend to a reasonable 3.6% dividend yield, as the lower earnings multiples has pushed up the earnings yield to roughly 6.7% here. This makes that the decline in the share price has increased appeal quite a bit, although that the same trends are seen across all consumer packaging businesses (especially food) in various degrees. On top of these operational headwinds, there is the development that interest rates have moved up a bit as well.

That being said, a gradual approach to buy some of these defensive names here might make sense, although that some differentiation is needed as many of these consumer brands (including less strong brands in the portfolio of General Mills as well) might lose their brand power over time. This is due to declining power of TV (advertising) as well as consumer shifting to more organic brand as well as nameless store brands. This makes me still quite cautious to load up on General Mills, but the sector at large is starting to look quite interesting.

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