Jerome Powell's heavy-handed interest rate increases at the Federal Reserve aren't proving magically delicious for cereal giant General Mills (GIS).
Actually, anything but tasty.
"The carrying cost of inventory is higher, interest rates are up. They're [big customers] trying to work their balance sheets," noted General Mills chairman and CEO Jeff Harmening on the company's earnings call Wednesday.
Added North America leader Jon Nudi: "Retailers are focused on inventory. One of the things that we feel more confident about is being able to supply the business after all the supply disruptions in the last few years, then feel like they don't have to carry as much safety stock. In addition to that, obviously, the inventory is more expensive. So, working capital is a focus as well. As we look at the absolute levels of inventory, they are some of the lowest levels we've seen on record."
That tight inventory management — due to more sluggish consumer spending and higher carrying costs — by large cereal buyers such as Walmart (WMT) and Target (TGT) has hurt General Mills' financial performance in two ways.
First, the company has seen volume declines at its two most important lines of business: North America Retail (powered by cereal brands Cheerios, Lucky Charms, etc.) and Pet (Blue Buffalo).
Fiscal fourth quarter volumes in each division dropped 8% and 2%, respectively. And full fiscal-year volumes at each division declined by 6% and 2%.
With volumes under pressure and inflation still elevated, General Mills' gross profit margins took a hit for the quarter and fiscal year.
Reported gross profit margins in the fiscal fourth quarter declined 180 basis points year on year to 34.4%. For the fiscal year, gross profit margins fell 110 basis points from a year ago to 32.6%.
For a serving of perspective, inventory levels at Target plunged 16% year over year in the first quarter as the discounter cut stock across its store to improve margins. The vibe for manufacturers like General Mills wasn't much better at mega food buyer Walmart — inventory dropped 7% from the prior year in the first quarter.
"Managing costs and inventory are two of the key controllables as we navigate an uncertain macroeconomic environment. We're improving inventory efficiency and merchandise flow and addressing placement in order to better serve customers, improve store in-stock levels, while also mitigating future risks if demand softens," Walmart CFO John David Rainey told analysts on a May earnings call.
The cautious buying by retailers has General Mills cautiously planning its next 12 months financially.
General Mills guided to 3% to 4% organic sales growth for its current fiscal year. It sees operating profits and EPS growing 4% to 6% year on year, excluding the impact of currency fluctuations.
Wall Street is also viewing cereal stocks as akin to sour milk: Shares of General Mills and Kellogg are each down about 8% year to date.
The S&P 500 is up 14% on the year.
"General Mills missed Q4 top-line expectations, driven mainly by unexpected NAR [national retailers] inventory reductions, which in turn raised more questions about the sector's go-forward growth profile. Despite more incremental margin expansion in FY’24 and FY’25 (driven partially by Pet), a lack of volume conviction as pricing laps increases uncertainty. Talk of increased promo activity and private label share gains, and a lack of clarity on F'24 volumes leave us sidelined," wrote Jefferies analyst Rob Dickerson in a client note.
If there is any saving grace for the cereal industry, it is that major retailers at some point soon will have to rebuild inventory. After all, they run the risk of not having product on the shelves to meet consumer demand.
"As we look at the absolute levels of inventory, there are some of the lowest levels we've seen on record. So, again, we don't believe that we can go much lower," Nudi added.
Brian Sozzi is Yahoo Finance's Executive Editor. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn. Tips on deals, mergers, activist situations or anything else? Email brian.sozzi@yahoofinance.com
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