General Mills: The Time To Begin Buying Approaches

Summary

• The company indicated that it competes in a challenging era where the pace of change is greater than ever and it needs deliver innovation-driven revenue growth.
• The company initiated a new global organization structure and accelerated cost savings efforts, but admits it reduced investments in key product categories too much and its execution suffered.
• The company’s main goal for fiscal 2018 is to return its business to sustainable revenue growth, while also investing in innovation to accelerate growth.
• Priorities to drive revenue growth include growing its global cereal platform; improving its yogurt performance; investing in product platforms; and managing its foundation brands.
• Investors should begin buying shares to collect about a 3.5% dividend yield as the company works to reignite its yogurt business and moves into the functional food market.

General Mills' (NYSE:GIS) shares are languishing as it continues its efforts to turnaround the embarrassing performance of its yogurt business and to adapt to changing consumer food trends. As we review financial media reports about the company, we are getting a sense that negativity is peaking in regard to the company and a buying opportunity is beginning. While the company's shares could fall further on a strong overall market sell off along with rising interest rates, the time has come to begin purchasing shares to capture a 3.5 percent dividend to reinvest. Long-term conservative investors should not fear an investment in GIS's shares in the face of the negative media attention. Rather, investors should embrace the opportunity to buy into this dividend growth stalwart at a more value-oriented price while they can. As our readers should remember, we never bet against any of the major American food giants as they have too many levers to pull to drive growth including internal innovation, acquisitions and divestitures. As we have stated in past articles on GIS, the company's struggles are not solely related to market based changing consumer trends, but also its missteps in their effort to drive growth in its yogurt business. (In 2016, nine of the top ten yogurt brands recorded increased sales and only GIS was the exception.)

While GIS has yet to be able to capitalize on increased consumer demand for Greek yogurt while its competitors have been able to do so, it is also: 1) making its legacy food products healthier; 2) innovating internally to create healthier foods; 3) investing in start-up companies that serve the "functional food" market; and 4) divesting fading legacy products while also acquiring companies serving the healthier organic/natural food market. With the company's efforts in mind, let us look briefly at its latest quarterly results. In GIS' latest quarter, the outgoing CEO noted that the company is competing in a challenging era where the pace of change is greater than ever. The outgoing CEO also noted that to win in such an environment, it is necessary that GIS deliver innovation-driven revenue growth. The incoming CEO noted that fiscal 2017 included significant changes for the company where it implemented a new global organization structure and accelerated cost savings efforts to improve its efficiency. Despite such positive developments, however, GIS indicated that it pulled back too far in its investment in some key product categories and its overall execution suffered. While such execution efforts adversely affected sales/profit growth, the company was still able to record 6 percent constant currency growth in adjusted diluted earnings per share.

GIS' main goal for fiscal 2018 is to return its business to sustainable revenue growth. The company's seeks to invest in innovation to accelerate growth for businesses where it has positive momentum and to improve businesses where that are underperforming. The company also seeks to invest in improving its e-commerce capabilities and its strategic revenue management. GIS expects its fiscal 2018 profit and earnings per share growth to reflect strong cost savings partially offset by volume declines and investments. The company has also recognized significant progress to expand its adjusted operating profit margins in recent years, but continues to see opportunities for margin expansion. With such goal in mind, let us return to GIS' latest quarterly results. The company's net sales were $3.8 billion, a 3 percent decrease on a reported and organic basis. Net earnings increased 8 percent to $409 million and diluted earnings per share were $0.69. Adjusted diluted earnings per share were $0.73. For the company's North American retail business, organic net sales decreased 4 percent. Organic net sales for the company's Convenience Stores & Foodservice business were comparable to the prior year. Organic net sales for the Europe and Australia business decreased 9 percent. Organic net sales for the Asia and Latin America business increased 8 percent. Finally, net sales for GIS' Cereal Partners Worldwide ("CPW") joint venture increased 3 percent in constant currency.

GIS reiterated that U.S. food industry trends in the last few quarters have been challenging and it is not planning for a significant turnaround in those trends in fiscal 2018. The company expects full year adjusted diluted earnings per share to increase 1 percent to 2 percent in constant currency. As noted above, GIS main objective for fiscal 2018 is to drive revenue growth across all of its businesses, especially in the U.S. The company will work to attain such goal by investing in its brands with increased media spending and a higher level or new product innovation. For fiscal 2018 GIS has identified the following four global priorities that are most critical to improve its revenue growth trends: 1) growing its global cereal platform including CPW behind compelling new products, innovation and advertising investment; 2) improving its U.S. yogurt performance through fundamental innovation; 3) investing to drive differential growth across several global platforms where it has good revenue momentum already; and 4) managing its foundation brands with appropriate levels of investment. (For a highly detailed discussion of the company's efforts with respect to each priority see the transcript for GIS' latest quarterly conference call.)

While GIS is facing multiple adversities across its businesses, we believe the company fully understands its missteps and has set out detailed strategies to carry out the four priorities noted above. As widely publicized in the media, GIS' yogurt troubles continued in the latest quarter. (For a more detailed discussion of GIS's yogurt troubles see this excellent article.) We believe that the company's innovative product development and marketing expertise will help it overcome its missteps in the yogurt market. If GIS did fail to internally develop a successful line of yogurt products, however, it could seek yogurt success through an acquisition. While GIS's yogurt problems may seem insurmountable, our readers should know that we never bet against the success of a dominant American food company over the long term. With that said, GIS also plans to offer more products in the "functional food" market. Food companies offering functional foods claim such foods have health benefits, such as decreasing cholesterol and preventing cancer. (See our article on functional foods.) The company is moving further into functional foods through internal innovation but is primarily focused on acquisitions/investments in functional food start-ups that they may later acquire.

While the company is taking steps to jumpstart revenue/earnings growth, its shares trade at a more value-oriented price as it transforms to turnaround its yogurt business and to adapt to U.S. organic and health food trends. The company is also increasing its cereal investments, increasing its healthy snacking products offerings such as its yogurt and snacks businesses and driving double-digit growth in its natural and organic food portfolio. GIS understands that consumers want more natural foods, with simpler ingredients. The company also knows that consumers are avoiding gluten, simple carbohydrates, artificial ingredients and seeking out more fiber, protein and whole grain. GIS also understands 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. We believe that GIS, a known innovator in developing and marketing food brands, will overcome its "yogurt problems" and succeed over the long term through internal innovation and acquisition of food brands that meet consumer's changing tastes. With this in mind, we also believe that investors should begin a position in GIS shares and collect a 3.5 percent dividend to reinvest as the company adapts to a changing food market.

Our view

We believe that the negativity surrounding GIS and its shares is beginning to peak. Now while we cannot predict a bottom in the company's shares, we do know that if we did not already own the company's shares we would begin accumulating such shares now. There are many uncertainties surrounding GIS and the food market generally. For example, investors are greatly concerned about GIS' ability to compete against popular store-branded products such as those that sell at Trader Joes. Investors are also concerned about the effect of Amazon's (AMZN) purchase of Whole Foods (WF) on the food market generally. While such concerns are legitimate, we find investing during a time when such concerns exist is when the best gains are made. When shocks occur to a staid industry such as the food industry, investors tend to shoot first and ask questions later by assuming that existing players in a market will fail before the battle has even begun. We believe differently and that is why we believe long-term investors should begin a position in GIS shares now. Although many of GIS's existing brands remain successful sellers, its remains focused on natural/organic food trends that many smaller nimble inventive companies more readily recognize. GIS has noted that its industry has become "entrepreneurial" and it must compete against many smaller food brands.

The adversities GIS faces, including its yogurt missteps, are not to be underestimated but we would never count out the abilities of this over 100-year old company. While some investors might be overly negative on the company's near-term prospects, such investors do not know the plans it has to address and overcome such adversities. For example, GIS through internal innovation and its investment arm investments is making a strong and consistent move into the functional food market and is likely to be a significant and successful player in such market, thereby driving revenue/earnings growth. The company continues to faces weak food industry trends as it also experiences intense competition. The company, however, also continues to adapt legacy food products by decreasing salt, sugar and the number of ingredients in such products. Further, GIS continues to reduce costs through restructuring activities. GIS's strong brands will likely protect it partially from lower-cost product competition. The company's earnings growth, however, will continue to be pressured by weak U.S. demand, slowing international growth and increased marketing and merchandising investment to drive revenue/earnings growth.

Despite near-term adversities, GIS will succeed long term due to its strong brands; product and marketing innovations; its push into the growing functional foods market; profitability and cash flow; and long-term record of earnings and dividend growth. GIS shares currently have a dividend yield of about 3.50 percent. Earnings estimates for fiscal year 2018 are $3.13 and for fiscal year 2019 are $3.24. We should note that earnings estimates have fallen for each year in recent months. The company has a price-to-earnings ratio of about 17.70 based on fiscal 2018 earnings estimates and a price-to-earnings ratio based on 2019 fiscal year earnings of about 17.10. We recommend that an investor wait to buy the company's shares in the price range of $51.85 to $55.10 (a price-to-earnings ratio range of about 16.00 to 17.00 based on 2019 fiscal year earnings).

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Analyst’s 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.