GIS - General Mills: Underlying Volume Challenges

2023-07-30 20:38:27 ET

Summary

• General Mills has managed inflation reasonably well, but the issue is that strong pricing hides huge underlying volume declines.
• While earnings hold up well and are expected to increase this year, I fear the continued higher pricing of its products versus competition.
• Despite a recent pullback, I am waiting for a slightly more attractive entry point as I am not impressed with the underlying business performance.

A year ago I concluded that General Mills ( GIS ) was milling along, after it optimized its portfolio in recent years, creating a stable consumer staple business with slightly improved growth prospects. This created a fair, but not necessarily very attractive situation given the (interest) rate environment.

While growth turned out to be better than expected last year, driven by higher and longer period of high inflation, the components of the growth were disappointing, something which investors realize as I am not buying the dip just yet.

Creating Some Perspective

Pre-pandemic, General Mills was a $17 billion business if we look at the 2019 numbers, with operations being substantial in North America, complemented by smaller operations in Europe and Asia. The company had strength in cereal, yogurt, snack & meals, dough & backing mixes, as well as animal food following an $8 billion deal to acquire Blue Buffalo.

The company generated about $3.6 billion in EBITDA on that revenue basis, needed as net debt was reported at $13.0 billion following the deal for Blue Buffalo. Adjusted earnings of $3.20 per share translated into a modest 15 times earnings multiple, as I was happy with the adjustments made to these earnings.

Since 2020 shares have gradually risen from levels in the mid-forties, to $70 in the summer of 2022 as the company made some small alterations to the business between this period of time. This included a $740 million sale of a majority stake in Yoplait in Europe, while adding a $1.2 billion Pet Treats business to the animal food platform. The company furthermore sold the Helper and Suddenly Salad business in a $610 million deal, while acquiring TNT Crust in a deal adding $100 million in sales, creating a lot of smaller moving parts.

Through the third quarter of 2022, the company improved earnings to a run rate of $4 per share as EBITDA improved to nearly $4 billion, all while net debt was cut to $10.7 billion. This made that leverage ratios have fallen below 3 times, while the company traded at a reasonable 17 times earnings multiple.

Trading Stagnant

Over the past year shares of General Mills have traded in a $75-$90 range, with the higher end of the range visited as recently as May as shares now trade near the lower end of the range again.

In June of last year, the company posted a 5% increase in sales to $19.0 billion as adjusted earnings per share rose by a similar 4% to $3.94 per share, with net debt reported at $11.0 billion. In an inflationary environment, the outlook was not too impressive with organic sales seen up by 4-5% for the fiscal year 2023, with adjusted earnings per share seen between flat and up 3%.

The company hiked the full year guidance alongside the release of the first quarter results, as it did the same during the second and third quarter, seeing full year organic sales up as much as 10-11% with adjusted earnings per share up 8-9%. These were big hikes as the company probably underestimated inflation at the start of the year.

By June of this year, General Mills posted a 6% increase in full year sales to $20.1 billion with divestments hurting some of the sales numbers. Adjusted earnings rose as much as 9% to $4.30 per share, with the numbers being in line with GAAP earnings, as net debt being coming in flattish at $11.1 billion, all while EBITDA still comes in around $4 billion.

Note that the fact that margins kept up during a high inflationary environment comes as the revenue growth composition was really poor with full year pricing/mix up as much as 15% as volumes were down 8%, resulting in some operating deleveraging, if not for the fact that prices were up a bit higher than actual cost inflation.

The outlook for the upcoming fiscal 2024, a year dominated by moderating cost inflation, is relatively solid with organic sales seen up 3-4% and earnings per share seen up by 4-6%. Backed up by this guidance and a solid year, the company announced a nine percent hike in the quarterly dividend to $0.59 per share, pushing up the dividend yield to more than 3% here, needed to compete with risk free rates which by now are much higher of course.

What Now?

The reality is that if any, there might be some downside risks to the guidance as we are seeing a disinflationary environment to some extent, as the company has seen much lower volumes. This came as consumers were really impacted by high inflation and thus cut back on spending (well not really spending in dollar terms, but certainly in volumes term).

With the company trading at 17–18 times reported earnings, and around 17 times earnings based on the forward guidance, valuations look a lot more reasonable with leverage under control, after valuations ran a bit hot earlier this year.

Given all this, it seems that appeal is improving here, yet being mindful of the underlying weaker performance (that of significant price hikes and volume declines) I require a slightly more compelling entry level in the higher sixties before potentially getting involved here.

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