Sunday, November 11, 2012

General Mills Equity Research

Conditions are tough in the US food sector. Everyone knows that. But when the going gets tough, the tough get ordered around by the General. In this battle General Mills (NYSE: GIS) appears to be executing its plans very effectively and its latest results are the latest demonstration of its management’s ability to fit all terrains.

The last time I looked at General Mills I concluded that it needed to consolidate its core US markets by focusing on snacks and look for growth in its international segment. Before analyzing how this plan is working, it’s a good idea to see how it compares with the rest of the sector.

What the Food Industry is Saying

The market has loved Kraft (NASDAQ: KRFT) this year because of its upcoming split and its focus on the faster growth snacking category. The company is executing well and the market is giving it the benefit of any doubt by chasing its yield. Meanwhile, Kellogg (NYSE: K) has had struggles with pricing as its commodity input costs have risen sharply and it has had to deal with the tricky issue of shoppers trading down to discounted private label brands. When Kellogg tried to raise prices in certain lines the price sensitive consumer responded by sending its volumes down. Its challenge is to demonstrate it can get the mix right.

Turning to H.J.Heinz Company (NYSE: HNZ), this company has found it difficult in the US and has shifted strategy by focusing on its core ketchup and sauces brands as well as emerging market growth. Its last results were no more than ok with gross profits rising only 1.9% with organic sales growth up 4.8%. Unfortunately, Heinz doesn’t break out numbers from its nutrition division so it is difficult to see how much it was responsible for its international growth.

In summary, Kraft is going for growth in snacking. Kellogg is hoping for an improvement in US volumes and cost inflation while Heinz is focusing on its core brands, divesting non-core operations and going for emerging market growth.

I would argue that General Mills is doing all these things in one!

General Mills Strategy and Latest Results

The strategy is to go for growth via buying business exposed to emerging market growth while consolidating its domestic position with a renewed focus on snacking and higher growth categories like yogurt, Haagen-Dazs, and healthy snacks. Meanwhile it's controlling costs and looks set to benefit from a more benign cost inflation environment.

A breakdown of segmental operating profits in the quarter.

Much of the international profit growth was thanks to the contribution of the acquired Yoplait operations. Moreover, the company bought a Latin American focused food company (Yoki) whose numbers will start to be integrated in the next quarter. Europe is proving relatively better for General Mills than most in the sector are reporting and I think this has much to do with the highly popular and growing Yogurt category in Europe.

Turning to the US, segment profits were down 2% and sales fell 1% with volume down 2%. While this does not appear impressive the underlying picture is actually a bit better. Having dealt with 10% cost inflation last year, its forecast for this year is 2-3%.

It also appears to be a bit closer to an inflexion point with US yogurt and cereals. Both declined in the last quarter but with cereals, management argued that it is largely an issue of timing merchandising. Unit volume growth is predicted for the rest of the year and moderating cost inflation will help a lot here. As for yogurt, there have been a number of recent product launches and marketing initiatives in order to turn the sales decline around. We shall see.

Where Next for General Mills?

I think more of the same. Investors are in love with dividends now and see them as a proxy for very low US treasury yields. If a company can demonstrate the ability to generate stable cash flows and a commitment to paying a high dividend than investors will reward them.

In General Mills case, there is some upside from its execution and the moderation in commodity costs. It is doing the right thing by buying emerging market businesses and expanding operations there. Meanwhile its snacking brands continue to grow strongly. Going forward much will depend on how successful the new product launches in yogurt will be in the US.

There is nothing particularly sexy about the business or its ‘17x PE ratio for mid-single digit growth’ proposition but if investors want a stable 3.4% yield then this is a good way to get it