General Mills Offers Defensive Growth Prospects

General Mills $GIS is an interesting defensive stock that appears attractive because it offers a few key plus points. I’ve listed a few of them in bullet form below

• Defensive end markets of food and yogurt
• Good exposure to lowering commodity prices
• Strong dividend yield currently around 3%

So is General Mills an attractive stock to buy?

General Mills is ubiquitous name in the US Households through its cereal brands, healthy snacks, ready-made meals (Pillsbury etc), Haagen-Dazs ice cream and Yogurt (Yoplait) offerings. The last of which is growing quicker than the other products and, accordingly, the co is busying acquiring the international business of Yoplait. Next year will be about General Mills increasing pricing in order to benefit from the retention of market share that they fought for (via promotions, discounts etc) in previous years. However, the co is predicting that media spending will track sales growth so the management are unlikely to generate any operating efficiencies there.

This type of stock will always appeal to fund managers and investors because it provides good income and helps balance risk in a long only portfolio. I like the potential for future margin expansion coming from exposure to commodity prices coupled with its defensive nature. Indeed, over the last five years General Mills has grown operating profit every year (CAGR of 7% over the period) and EPS every year (CAGR of 12% over the period).

General Mills Q4 and Full Year Results

General Mills recently gave results and they were pretty good, however the outlook was weaker than the company had previously forecast. The good news is that the market had largely priced this in because the main cause is commodity price inflation. All of which suggests that if these prices continue to moderate-in line with the tightening attempts in many emerging markets-that General Mills could see some ‘upside surprise’ to gross margins. I’ve outlined historical cost inflation and gross margins for General Mills below

General Mills Estimates(%)	2007	2008	2009	2010	2011	2012
Input Cost Inflation	4	7	9	-3	4	10 to 11
Gross Margins	35.9	35.1	36.4	39.7	39.4	Lower

It is easy to see the inverse relationship between gross margins and input cost pressures. Moreover, this year’s cost inflation push is even more pervasive because commodities are up across the board and from relatively weaker comparables. In fact, the company is predicting lower gross margins as well as a low adjusted EPS growth of only 5% for next year.

Delving deeper into the results reveals that US retail sales were down 2% but international sales (constant currency) were up 16% respectively. This should provide little succour to shareholders because US retail sales still make up over 76% of segmental operating profits but international is only 10.7%. US retail sales were down but this is largely due to less price discounting and promotions. Accordingly, overall, full year operating margins expanded from 15.1% in 2010 to 16.6% in 2011.

General Mills Evaluation

Listening to the conference call, the management are predicting a tough time in 2012 and, gross margins are seen as being lower. Similarly, the forecast adjusted EPS growth of 5% (261c from 248c) is not particularly attractive. However, I think the co could beat this guidance with lower commodity costs; however, my concerns are with the stock’s evaluation and sales growth.

At $37.26 General Mills has a market cap of $23.81bn and an EV of $30.17bn which, in my opinion, is a bit rich for a company which has generated $878m in free cash flow. In addition, the co is forecasting $670m in capital spending next year against $649m in 2011. Given that EPS is predicted to rise by 5% only, then this suggests that next year’s free cash flow generation could be similar to this year’s. A forward PE of (37.26/2.61)=14.3x and FCF/EV of around 3.2% is not particularly exciting for a company with low single digit sales and EPS growth.

In addition, the free cash flow barely covers the dividend which suggests that long term dividend growth will be tough for General Mills. I think there are better ways to play a correction in commodity prices. The bulk of General Mills products are hardly high growth so whilst it is a fine investment for investment managers looking to park cash in a defensive manner, it will not attract GARP focused investors. I took a pass.

Anite Signals Strong Growth for 4G and LTE Spending

Ixia $XXIA and Spirent $SPT investors got an early read across from wireless and handset testing company Anite $AIE. Anite’s gave a final results statement and gave the stock market an update on how 4G and LTE deployment is taking place.  In summary on their wireless division,

‘2011 saw improved financial performance within the Wireless division, driven by both customer spending recovery and organic business growth. We believe the recovery phase is complete and that its 2012 results will be driven by business growth alone. Wireless is better positioned to take advantage of its existing and new markets than in the past and we believe that the LTE opportunity is also likely to be deeper and longer lasting than previous technologies.’

In addition, Anite talked of increased investment in 2G and 3G products as well as LTE. This augers well for the likes of Alcatel, Spirent and Ixia.

However, the key to longer term growth is the demand pull from the use of smart phones with data demanding functionality. This is particularly relevant when IP and video data is increasingly being used because it is bandwidth intensive. Naturally, this puts pressure on the network operators and handset manufacturers and testing solution providers will benefit if their customers are under pressure to invest in new technologies.

Interestingly, Anite mentioned that the demand for legacy systems has..

‘proved more sustained than expected and we continue to invest in this area.  However our main focus is currently on LTE, although the pace of change is accelerating and we are already planning for the next generation.’

Growth in the Wireless Market

 Anite referred to the longer term demand drivers here

‘Sales of smartphones are expected to grow 61% year-on-year- making the market ever more complex. While there is little growth in voice and text in developed markets, mobile data traffic is expected to grow by 6.3 exabytes (1 billion gigabytes) a month by 2015, a 25-fold increase over 2010^’

Industry Handset Production Forecast (m)	2010	2015
2G GSM	700	300
3G (WCDMA)	400	950
LTE	0	75

LTE is being deployed quicker than 3G ever was, simply because the adoption of smart phones is driving the need for a network upgrade. This is distinct from the early 2000’s when 3G was rolled out before the handset technology existed to take advantage of the network. It really is different this time.

In general, this is a very positive update and augers well for Ixia, Spirent and Alcatel. There doesn’t appear to be any slowdown in network upgrades and legacy system sales are holding up well.

Standard Chartered and the Property Market in China

Standard Chartered $STAN gave a bullish trading statement today and the market received it warmly, however the share price move looks to be a blip in a pronounced downtrend

I suspect the main reason for this is that investors have been pricing in a slowdown in Asian growth following tightening measures by China. In addition, the knock on effect of a temporary slowdown in industrial production following the disaster in Japan has scared investors. So is Standard Chartered a stock worth buying?

Is Standard Chartered Worth Buying?

I think not. Turning to the Standard Chartered statement, it seems quite positive...

“Standard Chartered is on course to deliver another strong first half.  We anticipate delivering cost growth broadly in line with income growth for the first six months of 2011. The credit environment remains benign across Asia. We are advantaged by a very strong balance sheet which remains highly liquid, very well capitalised, diverse and conservative; and are capturing increasing levels of business from our markets across Asia, Africa and the Middle East. "

...however, if we look into Standard Chartered said about regional performance, there is a red flag waving here...

“Sources of income growth remain well diversified, both by product and geography. Whilst income in India is lower than in the first half of 2010 and growth in Africa has been muted, this has been more than offset by very strong performances in Hong Kong, Singapore, Malaysia, MESA, China and Indonesia.”

...and the continued strength of Asian credit expansion is supported by other evidence. In normal circumstances, this would not be a matter for concern however China has been consistently raising reserve requirements in order to tame domestic demand and commodity price inflation.  The good news is that commodity price pressure is abating...

..but it is not clear if this is the start of a gently managed moderation or the beginning of a prolonged crash. The former would be good news for Standard Chartered but the latter would be damaging.

Anthony Bolton on China

It was interesting to read what top fund manager Anthony Bolton of Fidelity China Special Situations said recently concerning inflation and property prices in China. For example on inflation...

“I would not want to say that inflation is not a problem but I do not think it will stop the bull market unless it gets completely out of control. The authorities must tread a delicate path between slowing the economy to alleviate inflationary pressures and suppressing growth too much but I believe they will strike the right balance. I am expecting growth to fall back to 7-8% compared with last year's 10%, but that is still a very attractive level relative to the developed world.”

On the property market in China, Bolton cites the reports of empty cities and the speculation over 65million empty apartments. However, he concludes that the mortgage debt held against the properties is not high so he feels the long term picture is ‘very favourable’.

I’m not so sure and I think a cautious approach should be taken here. The good news is that the Chinese Government has the reserves to stimulate the economy if there is a sustained slowdown in housing. However, if there is a crash, China related equity investors-particularly with the US housing crash in their minds- won’t be slow to price this in negatively.

FedEx Bullish Conference Call and Growth Forecasts

FedEx gave $FDX gave Q4 results and the stock markets cheered them by sending FedEx stock 2.6% higher. Essentialy, FedEx is a cyclical company and rather like its rival UPS $UPS it should be seen as a play on global growth. Indeed, this issue was articulated in more detail in this linked article which should search as a good reference point.

In summary, both FedEx and UPS are not investments I would make right now. This is not a negative call on global growth, rather, an expression of my view that there are better value plays which will give directional exposure to global growth. In addition, I believe there are better growth plays which can generate superior returns to buying either of these stocks. Neither have the 'outer' of a takeover, nor great cash flow yields with which to pay high dividends. UPS is currently yielding around 3% but that it is not particularly attractive.

More interesting, is to compare what FedEx where saying about the global economy and compare it with Ben Bernanke's statement today. I'll come back to this point later.

Growth Prospects?

For both FedEx and UPS, there appear to be some upside prospects, at least if FedEx's conference call is to be believed. I will summarize some of the key 'take-aways' from the conference call below.

• Near term ecoomic weakness caused by previously high energy costs and the disaster in Japan
• A stronger second half as consumption picks up and energy costs fall
• Growth to be continued to be led by industrial expansion
• Growth in Asia/Pacific and China seen as showing continuing strength and the current environment described as being 'very positive'
• Currently low Inventory/Sales ratio in the supply chain are seen as boding well for future growth

Both companies should see the benefit from lower energy costs in their margins and also in their revenue numbers as high energy and food costs act as a kind of 'tax' on discretionary spending.


Comparing FedEx with the Fed?

No not Roger Federer, but Ben Bernanke. In the conference call, FedEx gave some specific US GDP growth forecasts which will be interesting to compare with the recent downward revisions to GDP  forecasts by the Federal Reserve.

US GDP Forecast	Q2 2011	Q3 2011	Q4 2011	2011	2012
Federal Reserve January				3.4-3.9%
Federal Reserve April				3-1-3.3%	3.5-4.2%
Federal Reserve Revised				2.7-2.9%	3.3-3.7%
FedEx Forecast	1.9%	3.5%	3.4%	2.5%	3.0%

Interestingly, the FedEx forecasts are somewhat weaker than the Federal Reserve forecasts, even with the lowering of the numbers by the latter. However, they are both indicating stronger growth in the second half and in particular with consumption spending coming back. I consider these strong indicators for stock pickers to take advantage of.

Cognex Offers Growth but Lacks Visibility

Cognex $CGNX is a world leading company in the field of machine vision systems. As such, this makes this stock a direct play on growth in Global Investment in Machinery and Equipment (IME). Cognex sells machines that ‘see’ and help measure and quantify factory automation processes. Whilst, Cognex is a play on this kind of capital spending, it does have a few key industry verticals which can cause performance to be lumpy.

Cognex splits its company into three separate divisions

• Factory Automation-(70% of sales) of which Auto production is a key vertical, Solar is a strong growth area
• Semiconductor and Electronics Capital Equipment (SEMI) (17% of sales)
• Surface Inspection (13% of sales)

By far the most important is Factory Automation which is also the fastest growing and with the highest gross margins of around 80% The other two divisions have gross margins of around 50% and due to these factors and, according to the conference call, Cognex appear to believe that they can continue to achieve overall gross margins of 72-75%

Cognex End Markets

Frankly, Cognex has had very favourable tailwinds over the last two years which has made growth look artificially strong. The last recession was characterised by a severe cutback in IME and Cognex suffered accordingly. However, with the recovery investment has flowed back and the low base effects have created very strong looking growth for Cognex. Some details here on trading history here...

$1000s	2006	2007	2008	2009	2010	2011	2012
Revenue	238,318	225,683	242,680	175,727	290,691	319,450	360,510
growth		-5.3%	7.5%	-27.6%	65.4%	9.9%	12.9%
Gross Profit	173,480	161,333	174,253	119,340	213,130	234,796	264,975
gross margin	73%	71%	72%	68%	73%	74%	74%
Op Profit	44,473	28,136	25,104	-12,668	75,173	76,668	86,522
margin	18.7%	12.5%	10.3%	-7.2%	25.9%	24.0%	24.0%

The slowdown from 2008-09 is demonstrative of the cyclical nature of Cognex’s end markets. However it is worth reflecting on the weakness in 2007. This was largely a consequence of a combination of factors including weakness in the semiconductor industry; an over reliance on the weakening North American auto production; low penetration within factory automation in Japan and some administrative difficulties within the North American sales operation.

Cognex addressed these problems buy increasing diversification in end markets and by shifting the sales focus to the types of countries (China/India/Korea ec) that are expanding automated production. As for the semiconductor industry, around ten years ago 66% of Cognex revenue was generated by this industry but now it is less than a third. Cognex mainly sells into the semiconductor equipment manufacturers that integrate Cognex solutions into their products. The US sales operation was restructured and finally, Cognex formed a partnership with Mitsubishi in order to generate accelerate longer term sales in Japan.

Future Prospects

Cognex’s revenues will be largely tied to global IME, their success in introducing the new Dataman product (they aim for a run rate of $10m by the end of year, but are ahead of expectations) and in increasing the number of customers that utilise vision machine solutions. For example, Cognex is targeting the Life Sciences industry for long term growth. This sort of growth will take time as Cognex integrates with OEM with this type of solution.

Thinking shorter term, Japan automotive comprises less than 1% of Cognex sales, and it is hard to see too much disruption from Japan factory automation beyond a quarter or two. Longer term the Mitsubishi partnership should help Cognex in Japan and also in China, where Mitsubishi has a strong sales infradtructure. In the recent results Cognex claimed that the key factory automation market was actually getting stronger. Surface inspection revenues tend to be lumpy from quarter to quarter, and semiconductor revenues were exceeding expectations.

Cognex Evaluation

Cognex has a strong balance sheet with $316.4m in cash and investments on the balance sheet. At a current price of $33.22 the market cap is $1.36bn and the Enterprise Value is therefore $1.17bn. It is a conservatively run company that has consistently generated strong cash flows.

$1000s	2006	2007	2008	2009	2010
Free Cash Flow	44,255	43,838	52,295	6,817	70,491
%Revenues	18.6%	19.4%	21.5%	3.9%	24.2%

On the other hand, revenues can be lumpy and earnings visibility is not great. The stock fell 10% after a disappointing forecast at the Q4 2010 results, yet they exceeded them in Q1 2011 and the Cognex share price soared. Buying Cognex is a tad tricky because we are in a period where manufacturing growth is moderating, so expectations need to be not unduly optimistic.

Nevertheless, on balance, I think Cognex has good long term prospects and analyst forecasts have it on an EPS of $1.49 and $1.77 for 2011 and 2012 respectively.  Whilst this seems expensive on a PE ratio basis, Cognex generates strong cash flows and has 23% of its market cap in cash and investments. I think it is better priced at $37 which gives 10% upside from the current price of $33.22. I picked some up.