General Mills: Investors Should Buy the Dip Following Earnings

The company had outsized expectations for the fourth quarter due to the Covid-19 pandemic and largely topped all of them

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Jul 02, 2020
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General Mills Inc (GIS, Financial) has been an excellent investment so far in 2020, with the stock returning nearly 13% year to date while the S&P 500 has lost slightly more than 4%. Not a bad return for the 150-year-old packaged foods company that counts Cheerios, Betty Crocker, Yoplait and Blue Buffalo among its most famous brands.

Much of this gain is due in large part to the Covid-19 pandemic, with the assumption that consumer packaged goods companies would be a prime beneficiary of the stay-at-home orders that were given out throughout the world in an effort to curb the spread of the virus.

This gave way to outsized expectations for General Mills’ most recent quarter and the company largely lived up to the hype. The market may have priced in the quarter as shares actually sold off by 2% following the earnings release. Let’s look at the company’s quarter to see if investors should use the weakness to buy the stock.

Quarterly results – Topping heightened expectations

General Mills reported fourth-quarter earnings results for fiscal 2020 on July 1. Revenue increased 21% to $5 billion, which was $43 million higher than Wall Street analysts had expected. Of this growth, around 7% was due to an extra week in the quarter compared to the prior year. Adjusted earnings per share improved 33% to $1.10, which was 4 cents above estimates.

Organic growth for the quarter was 16% as consumers shifted to stay-at-home dining in many parts of the country and world. While outstanding, this was still slightly below estimates for organic growth of 16.9%. This was likely the main culprit for the slight decline in the share price following the earnings release.

Still, this is outstanding growth for a consumer staple company and evidence that General Mills was able to operate its business to meet the increased demand for products. Of this organic growth, higher net prices and mix contributed 3% with the rest coming from increased volumes.

For fiscal 2020, revenue was up 5% to $17.6 billion and adjusted earnings per share increased 12% to $3.61. The company had 4% organic growth for the fiscal year. The Covid-19 pandemic is estimated to have added 3% to organic growth for the year.

The North American market really surged higher during the quarter, with 36% sales growth for the region.

The U.S., where General Mills earns approximately two-thirds of its revenue, had 32% growth. This region had strong growth in heavier products such as refrigerated baked goods, soup, flour and dessert mixes. All operating units had growth, led by Meals & Baking retail sales, which increased 75%. Every other unit had at least 10% growth.

General Mills defended and grew its market share quite well for both the quarter and year.

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Source: General Mills’ Fourth-Quarter Earnings Presentation, slide 11.

As you can see, the company lost some market share in Yogurt for both the quarter and year, but the remainder of General Mills’ top 10 products took market share from competitors during the fourth quarter. This shows the company was better at capturing higher spending among consumers.

Pet sales advanced 37% to $555 million. The company’s $8 billion purchase of Blue Buffalo in April of 2018 continues to pay off.

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Source: General Mills’ Fourth-Quarter Earnings Presentation, slide 12.

The company has seen Blue Buffalo’s household penetration rise 460 basis points in just two years. Net sales for the pet food brand were up high double-digits with growth found in all retail channels.

Europe and Australia, which are reported as combined segment, had sales growth of 6% due to higher demand for food products related to the coronavirus pandemic and 7% of additional sales due to an extra week. Currency exchange reduced results by 4%. Old El Paso and Betty Crocker were sources of strength during the quarter.

There were two areas of weakness, though both are among smallest components within General Mills. Convenience Stores and Foodservice sales declined 24% to $393 million. Much of this decline was due to reduced away-from-home sales as consumers didn’t eat out as much under stay-at-home directives. Asia and Latin America sales were down 12% to $349 million, also primarily due to less demand for eating out.

Another area of growth that General Mills took advantage of was e-commerce sales. Online sales accounted for 9% of total sales in the quarter, up from 6% for the first three quarters of the fiscal year and 5% for all of fiscal 2019. The ability to personalize communication and promotions to customers helped drive higher growth.

Rounding out the quarter, adjusted gross margins improved 80 basis points to 36.1% while the adjusted operating rate was higher by 40 basis points to 17.7%. Cash from operating activities increased 31% to $3.7 billion while free cash was up 42% to $3.2 billion.

General Mills used this free cash flow to distribute $1.2 billion of dividends and reduce debt by $950 million. This reduction in debt will help lower interest expenses in the coming years, which was down to $446 million in fiscal 2020 compared to $522 million in fiscal 2019.

General Mills didn’t offer specific guidance for fiscal 2021, but did say that it expects to curb costs by 4%. This will be offset by higher costs inputs. Demand for products is expected to be slightly higher due to Covid-19.

Yahoo Finance data shows analysts expect earnings of $3.49 per share for fiscal 2021, but that is likely to change as analysts incorporate the latest results and the company’s expectations for the new fiscal year. Shares of General Mills trade at 17.3 times next year’s expected earnings, which is slightly above the historical average price-earnings ratio of 16.8.

Final thoughts

Great things were expected of General Mills during the quarter, and the company largely exceed the vast majority of them. Top and bottom lines had strong growth, fueled mostly by the transition from away-from-home to stay-at-home dining.

The one area the company came up short was for organic growth estimates, though results here were quite good.

Shares of General Mills are slightly expensive against the historical average valuation, but I think the company’s most recent quarterly performance warrants this valuation.

General Mills also offers a 3.2% yield. Though the dividend has been frozen for the past two years as the company pays down debt, it hasn’t cut its dividend is nearly 120 years.

Strong business execution plus an attractive dividend yield that likely won’t be cut makes General Mills look attractive even at the current valuation.

Disclosure: the author has a long position in General Mills Inc.

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