General Mills (GIS) ended its fiscal year 2017 on a lighter note with another sales decline of 6% and a modest 2% drop in bottom-line despite some aggressive cost cuttings. Although General Mills outperformed the consensus estimates, a deeper digging reveals that fundamental growth challenges remain intact. As a result, General Mills has massively underperformed the market, and its performance is likely to remain weak in the near-term as falling organic volumes overshadow small improvements in profit margins.
General Mills has stuck in a loop. The shrinking sales of cereals, yogurt, and meals & baking products are putting pressure on earnings and free cash flow. On the flip side, the aggressive reduction in distribution and advertising spending to improve profit margins is negatively impacting volumes and brand appeal in a very competitive landscape while consumer preferences have become highly dynamic.
Source: General Mills, North America Retail Segment
The U.S. yogurt market is consistently growing as opposed to cereals industry, which is suffering from a slump in breakfast cereals. However, the worst part is that General Mills has failed to compete despite increasing demand for breakfast yogurt and it is evident from a sharp 18% drop in yogurt sales during the fiscal year 2017.
According to Mintel, the U.S. yogurt market is likely to grow at a CAGR of 4.6% to reach $11.4 billion by 2021. However, General Mills needs a dramatic turnaround to avoid further loss of sales and market share. The company is releasing a French-style yogurt called Oui by Yoplait to disrupt the U.S. yogurt market. The French yogurt is relatively a new category in the U.S., and the success of Oui by Yoplait is uncertain at the moment. However, General Mills’ remarkable innovation capabilities in yogurt business combined with aggressive TV and digital marketing support will help it create a new premium yogurt category. The continued expansion of well-performing Liberté and Annie’s organic yogurt and rollout of new flavors of Yoplait in the traditional yogurt category will enable General Mills to make a comeback against Chobani and Dannon.
General Mills has a portfolio problem, and simply reformulating core brands may not help regain sales growth momentum. Instead of playing a safe game, General Mills should boost its innovation capabilities and aggressively market its health-focused brands to turnaround sales trend. The profit margins may suffer in the short-term, but increased investments promotional campaigns, strategic revenue management, and development of e-commerce capabilities will help curtail falling sales trend during 2018.
General Mills is the leading cereals maker in the U.S. with 26% value share, but changing consumer preferences continue to hurt its cereals business, including a most recent drop of 3% during 2017. General Mills will experience more headwinds as the U.S. breakfast cereals market will shrink by 5% to $10.1 billion by 2021. The turnaround of cereals business is one of the four priorities General Mills will focus on this years. The rollout of ‘‘Good Starts with G’’ marketing campaign, which focuses on gluten-free products and whole grain ingredients, will help improve the appeal of core cereals brands, including Reese's Puffs and Lucky Charms which recorded a 3% sales growth during 2017. General Mills will also support the release of three new flavors of Cinnamon Toast Crunch to replicate the past 3-year compounded annual growth rate of 6%.
The opportunity is bright is one the broader level as the global breakfast cereals market will grow at a compounded annual growth rate of 4% to reach $43 billion by 2022. While North America and Europe are the largest markets, improving disposable income and lifestyle changes will drive a faster cereals consumption growth in Asia-Pacific. The expansion of its gluten-free and wellness focused global platform of cereals brands will also play a critical role in overcoming the current weakness.
Source: General Mills
General Mills is raising its bet on snacks bars, organic food brands, and ice cream. The global ice cream industry is mature and competitive, and yet General Mills is registering healthy sales growth with its super-premium brand Häagen-Dazs. The introduction of stick bars helped generate a double-digit growth in Europe, and this year General Mills is preparing for an aggressive geographic expansion of stick bars to replicate its success on the global scale. In addition to rolling out mini cups in the U.K., the launch of new innovative fruit and flower flavors in Asia will boost contribution from growing ice cream business. The geographic expansion in Asia will play a critical role in sustaining long-term growth. The augmentation of outlets network and a steeper penetration into retail distribution channels across India will help General Mills benefit from rapidly growing ice market which is expected to more than double to reach $3.4 billion by 2021.
The continued decline in cereals consumption will negatively impact sales, but consistently growing demand for snack bars across the globe is an opportunity to accelerate profitable growth. In the U.S., snack bars market is expected to expand at a CAGR of 7% to reach $6.3 billion by 2022 due to increasing demand healthier and convenient food options. General Mills is releasing more than 20 new products under the umbrella of Nature Valley to capture a bigger slice of the rapidly growing market. Furthermore, the aggressive marketing and a 30% increase in distribution of Larabar brands, including Larabar nuts, bites, and seed bars, will strengthen General Mills’ growth prospects in snack bars market.
General Mills is progressing with its multi-year cost savings program, which generated 130 basis points increase in operating margin during 2017. Last year, General Mills followed the footprints of Kraft Heinz (KHC) but failed to benefit from aggressive cost cuttings as a steep cut of $130 million in advertising and marketing spending left a 7% dent in organic volume sales. While the management will continue its profitability enhancement efforts, the overall pace of cost cuttings will moderate going forward due to a renewed focus on delivering balanced growth in sales and profit margins. The management did not specify the increase for the fiscal year 2018, but more marketing investments to support the release of new products will help improve top-line growth trends in the coming quarters.
Another positive aspect worth mentioning is its growing e-commerce footprints in the midst of rapidly spreading online shopping trends. Last year, the company recorded a massive 62% boost in e-commerce sales, and robust growth momentum will continue as General Mills enters into more strategic partnerships with e-commerce retailers around the world.
The S&P 500 Index is up 8.2% so far this year while the consumer staples sector has gained 6.6% value, but General Mills has significantly underperformed both with a price decline of approximately 11%. The market is valuing General Mills at a forward PE of 17.7x while the packaged food stocks are trading at a forward PE multiple of 19x, and discounted valuation makes sense. Despite a steep decline of more than 21% over the past twelve months, the stock performance is likely to remain weak due to a further drop in organic sales and a modest 1% to 2% increase in adjusted earnings per share during the fiscal year 2018.
I would suggest buying the stock on further weakness for the long-term holding as the management’s turnaround efforts, a renewed marketing strategy, geographic expansion of Häagen-Dazs and Nature Valley, and new product lines focused on wellness trends will deliver profitable growth in the coming years.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.