I haven't felt all that adamantly positive or negative about General Mills (NYSE:GIS) for a while now. While the company has some definite positives in its favor (a history of innovation and good international growth potential), it is also struggling with weak volumes and share loss in key categories. With the price close to fair value and an uncertain retail strategy in the United States, I'd still just as soon own other stocks in the consumer staples area.
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Another Good News, Bad News Type of Quarter
General Mills certainly did some good things this quarter, but once again there are some dark clouds on the horizon that can't (or shouldn't) be ignored.
Revenue rose almost 6% this quarter, with organic growth of around 2% on flat volume. U.S. retail sales rose about 2%, with all of that from volume. International sales were up a strong 19%, and I'd estimate that organic sales were up in the mid- to high-single digits. Last and least, the company's bakeries and food service business saw a 1% revenue decline.
Gross margin was surprisingly soft, up only a fraction of a point from last year and more than half a point below analyst expectations on grain costs and dilution from the Yoki deal. Operating income was up 9.8%, though, and the operating margin of 19.6% was more than a half-point better than expected due in part to reallocating spending from advertising to merchandising.
SEE: Analyzing Operating Margins
Share Data in the U.S. Is a Little Worrisome
Including Nielsen data in the due diligence process for food companies can be helpful in terms of telling you where market shares are heading, but it's worth noting that the correlations between that data and near-term financial (or stock) performance are not always as high as you might think.
To that end, General Mills' quarter was decent, even though the share data hasn't been looking so strong. The company seems to be losing some share to Kellogg (NYSE:K) in cereals and Campbell Soup (NYSE:CPB) might be regaining a little momentum in its namesake category. Kraft Foods (Nasdaq:KRFT) seems to be grabbing some share from General Mills' Hamburger Helper business, and while the yogurt business seems to have stabilized for now, it has stabilized at a pretty unimpressive level.
It's also worth noting that all of General Mills' merchandising and promotional efforts have still just resulted in flattish volume and modest price leverage. I don't want to overstate this, nor do I want to suggest that other packaged food companies like Kellogg, Kraft Foods or Campbell Soup are reporting great organic growth trends. Nevertheless, I think it's worth noting that there's just not that much momentum in the U.S. retail business, or at least it's not immediately apparent.
Sounds Like Business Conditions Are Still Challenging
I'd say that General Mills' management was basically positive but cautious on the call. Even though a lot of the company's commodity inputs are under control, it sounds like the gross margin could still be under some pressure for a couple of quarters. At the same time, the company pointed to a lot of uncertainty in the market - a little disappointing when you consider that the argument for consumer staples companies like General Mills is that they usually experience less economic volatility than other sectors.
The Bottom Line
With most packaged foods companies struggling to break free of the one-to-one elasticity of price and volume, I'm not all that excited about very many stocks in this sector. Kellogg and Nestle (OTC:NSRGY) are perennial favorites for me, but neither are so cheap as to be must-buys. Likewise, I'm not that impressed with the valuation on beverage and snack companies like Coca-Cola (NYSE:KO) or PepsiCo (NYSE:PEP), and most of the beer and spirits companies carry healthy valuations as well.
For General Mills, I continue to believe that mid-single digit free cash flow growth is a reasonable expectation for the future, as good growth opportunities in foreign markets offset the slower growth and increasing private label penetration in North America. All in all, that works out to a fair value in the low-to-mid $40s, which isn't terrible (especially with a dividend yield in excess of 3%) but also isn't terribly compelling at today's price.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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