The recent violent market overall market sell off is an event that should humble most investors. Such a sell off can wipe out years of an investor's gains or cause an investor to incur even greater losses. The swiftness of such a sell off should remind investors to dial back their hubris when investing in the stock market. We certainly feel the effects of such a sell off, especially on our most recent investments. With this in mind, we strongly recommend that all investors hold about 10 to 15 percent of its portfolio in stocks such as U.S. food giant General Mills (NYSE:GIS). On a relative basis, GIS is a safer "port in the storm" of market volatility that rewards investors with lower volatility, increasing dividends and ongoing share repurchases. We only wish that we owned GIS shares decades ago, rather than purchasing the company's shares a mere few years ago. Better late than never we believe.
During GIS's most recent quarterly earnings announcement, the company lowered its previous revenue and earnings estimates for fiscal 2016 to account for it Green Giant brand divestiture. The company also recognized cost savings from its restructuring activities and lower advertising costs that offset weak revenues to result in earnings growth. The company is currently engaged in multiple restructuring initiatives including job cuts and factory closings to generate cost savings and support key growth strategies. The company expects to record hundreds of millions in cost savings by fiscal 2017. GIS, like many other major U.S. food producers, has been struggling due to the shift in consumer's preference toward natural and organic food. To counteract weak revenue and profit performance, the company is increasing its investment in cereals to achieve growth, accelerating the performance of its healthy snacking products such as its yogurt and snacks businesses and driving double-digit growth in its natural and organic food portfolio. The company recognizes that consumers want more natural foods, with simpler ingredients. The company also recognizes that consumers are avoiding gluten, simple carbohydrates, artificial ingredients and seeking out more fiber, protein and whole grain.
As GIS gravitates towards smaller healthier brands, they will also save in advertising costs as organic and natural foods use less expensive advertising campaigns that use less expensive digital advertising campaigns as opposed to more expensive television advertising campaigns. The company also recognizes that marketing for smaller natural and organic food brands focuses on the product itself and what is in the product and the origin of the product. While the company is adding smaller organic and natural food products to its brand portfolio, the company is also focusing on improving the health image of its larger brands. For example, the company is reducing the sugar in its original Yoplait yogurt by 25 percent. The company also offers varieties of Cheerios that are now gluten-free. More recently, the company indicated that it reduced sodium by 20 percent across 10 of its key U.S. retail product categories at the end of 2015. We believe that GIS, an expert innovator in developing and marketing new food brands, will succeed over the intermediate and long term through internal innovation and acquisition of food brands that meet food consumer's changing tastes. We also believe that all investors should own GIS shares along with a handful of other major U.S. consumer food brands in their portfolio. Shares in such food companies serve as a counterbalance to more volatile shares of company's in other industries. Over the long-term, a GIS investor will be rewarded with increasing dividends, ongoing share price growth and modest share price appreciation.
Fiscal second quarter 2016 earnings
In December 2015, GIS announced adjusted earnings per share of 82 cents, a 2 percent increase from the year[-ago quarter. A strong U.S. dollar adversely effected earnings by 6 percent, but on a constant currency basis, earnings improved 5 percent. Total revenue decreased by 6 percent from the year-ago quarter to $4.42 billion due to lower volumes, adverse currency effects and brand divestitures. On a constant currency basis, revenue decreased 2 percent as international market performance offset the weak sales in the U.S. retail market. Adjusted gross margins expanded 60 basis points to 35.5 percent due to increased pricing and savings from cost reduction activities. Adjusted operating profits were about flat at $798.2 million as an increase in international market profits were offset by a decrease in U.S. retail market profits.
The company's U.S. retail division revenues decreased 3.5 percent from the year-ago quarter to $2.76 billion due to lower volumes. Sales for the division decreased across all the operating units as cereal, meals and yogurt recorded mid single-digit decreases, snacks and baking products businesses recorded a 1 percent sales decrease. Operating profit for the division decreased 2.5 percent to $600.4 million due to decreased sales that offset gains from lower advertising costs and cost savings from re-structuring activities. The company's international division revenues decreased 12.4 percent from the year-ago quarter to $1.16 billion due to adverse currency effects. On a constant currency basis, international division sales increased 3 percent. Operating profit for the division increased 19 percent on a constant currency basis to $136 million due to higher pricing and lower input costs. The company's convenience stores and foodservice division revenues decreased 4.5 percent to $505.8 million from the year-ago quarter due to lower volumes and unfavorable price/mix. Operating profit for the division increased 7 percent from the year-ago quarter to $102 million due to cost saving initiatives.
GIS adjusted its fiscal 2016 estimates lower to account for the impact of the company's Green Giant brand divestiture. The company expects fiscal 2016 net sales (on a constant currency basis) to decrease in a low single-digit rate and adjusted earnings per share (on a constant currency basis) to increase at a low single-digit rate.
GIS continues making acquisitions and introducing innovative products
While GIS is restructuring, the company is also engaging in multiple acquisitions to combat weak food industry trends amid changing consumer preferences. In particular, the company is acquiring companies that capitalize on the shift in consumer's preference toward natural and organic food. For example, GIS recently announced its acquisition of EPIC Provisions, a rapidly growing, premium meat snacks company that offers meat, nut and fruit bars in unique flavors including Bison Bacon Cranberry, Beef Habanero Cherry, Chicken Sesame BBQ, and Pulled Pork Pineapple. EPIC also offers products that include Jerky Bites and Hunt and Harvest Trail Mix. EPIC snacks are sold primarily in the natural food market channels, but are also sold at sporting and hiking shops including REI, as well as some conventional grocers. Just prior to the GIS' EPIC acquisition, the company announced its acquisition of Brazilian yogurt maker Carolina, a company known for its strong regional yogurt brands. Carolina sources high-quality milk from farmers and markets more than 20 different dairy product lines. In 2015, the company's most significant acquisition was natural foods maker Annie's.
Aside from GIS' acquisitions of food brands that appeal to changing consumer preferences, the company continues to invest in new products and marketing. While the company is making acquisitions targeted toward consumer trends towards healthier and more natural foods, the company still must consider what to do with many of their fading legacy products that are falling out of favor with consumers. Recently, for example, GIS divested its Green Giant and Le Sueur brands of vegetables. Ultimately, GIS has a previously stated goal of increasing its $600 million natural and organic food business to $1 billion by 2020. The company's goal is a reflection of trends that smaller, healthier food brands once considered niche are becoming mainstream food categories.
Our view
GIS is actively engaging in acquiring small to medium sized innovative companies selling into food categories experiencing outsized growth given that such food categories focus on organic and healthier foods incorporating simple and natural food ingredients. The company is also in the midst of divesting some of its legacy food brands while also adapting other legacy food brands by reducing salt, sugar and the number of ingredients in its products. In addition, GIS will continue to reduce costs throughout its organization. The company' brand strength will likely protect it somewhat from competition from less expensive products. The company's earnings per share growth will continue to be pressured by continued weak domestic demand, slowing international macro-economic growth and increased marketing and merchandising investment within the yogurt business which is needed to drive sales growth.
Despite the adverse market conditions GIS faces, positive factors in GIS' favor include its strong brands; product and marketing innovations; profitability and cash flow; and long-term record of earnings and dividend growth. The shares also currently have a dividend yield of about 3.05 percent. Over the intermediate and long term time frame, GIS will overcome the current adverse market conditions by adapting to food industry trends and thriving through product innovation, innovative marketing and acquisitions of companies that are successfully addressing such food trends. The company has a price-to-earnings ratio of about 22.85. The company's earnings estimates for the current 2016 fiscal year is $2.86 and for the 2017 fiscal year is $3.07. So, the forward price-to-earnings ratio based on 2017 fiscal year earnings is about 18.00. While an investor could buy the shares immediately for the long term, a pullback to a price range of $49.00 to $52.00 (a price-to-earnings ratio range of about 16.00 to 17.00 based on 2017 fiscal year earnings) before initiating a full position is recommended.
Disclosure: I am/we are long GIS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
