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General Mills Is No Longer Stale

Richard Saintvilus

NEW YORK ( TheStreet) -- The packaged food industry has been anything but appetizing this year. With names like Diamond Foods , ConAgra and Campbell Soup Company   all being hurt by weak volumes and compressing margins, I never bothered to give General Mills a second look. Not to mention, General Mills was already  losing market share to Kellogg's in some very important categories.

Now, I've never discounted that General Mills, which has a strong history of innovation and "outside the box thinking," would overcome this rough patch. The problem, though, has been the stock, which is up close to 30% year to date, and (in my opinion) is now slightly above its fair-market value.

However, despite the sluggishness that has overtaken the entire sector, management has always maintained a consistent long-term growth plan. And following the release of the company's fiscal 2014 outlook, which was provided at the Morgan Stanley Global Consumer Conference two weeks ago, General Mills, expensive or not, has suddenly become more digestible.

[Read: Kellogg's Stuck in a Box]

As with rival Kellogg and to a lesser extent Post Holdings , General Mills has always commanded the Street's respect -- particularly for the way it markets its products. With the company projecting stronger earnings growth for 2014, while also returning cash to shareholders, this suggests not only strong outperformance but, more important, margin expansion.

I believe going forward, the company's gross margin, as well as that of its rivals, will be the key differentiator in identifying value. In the most recent quarter, although revenue was up 8% year over year, which beat consensus estimates, the fact that earnings fell more than 16% highlighted struggles in operational efficiency, pricing pressure, or a combination of both.

And it certainly didn't escape me that, as impressive as the first quarter's 8% volume growth, this was driven mostly by acquisitions. Essentially, very little of that growth was of the "organic" variety, which measures a company's operational performance using only internal resources and excluding such events as mergers and acquisitions. Accordingly, I felt the stock would be stale for the foreseeable future. The Street had other ideas.

In fairness, though, General Mills was not alone in doing deals. This has also been the growth model for ConAgra, Campbell Soup, Nestle and so on. Unlike these names, however, General Mills was not as scrutinized by the Street, which was reflected in its strong stock gains.

[Read: Food Industry Faces Labeling Changes]

With management calling for a strong improvement in adjusted gross margin for fiscal 2014, along with mid-single-digit growth in segment operating profit, General Mills is rewarding investors for their confidence. Equally impressive is that management is confident that it can grow operating margin in each of the three business segments, which includes U.S. Retail, Bakeries and Foodservice and International.

Although international business, which grew 22% in the recent quarter should continue it upward trend, it remains to be seen to what extent management can boost U.S. retail, which grew just 3%, while bakeries/foodservice decline 1%.

The other thing is, with both Kellogg and Post expanding into new product categories, while also aggressively marketing breakfast foods/cereal where they are already gaining share, General Mills will find it challenging to grow margin without cost-cutting measures and efficiency improvements. And I haven't even mentioned the rivalry that exists with companies, like Kraft , in such categories as yogurt and dry dinners.

All of that said, it's not as if General Mills management is not aware of its challenges. That the company still guides for high-single-digit earnings of $2.90 for fiscal 2014 is encouraging. This implies a slight uptick in the otherwise lackluster U.S. retail business, which should benefit from new product launches and continued innovation.

To that end, I continue to believe shares will continue their uptrend toward the $60 area, given the strong growth momentum the company enjoys in international markets, which should continue to fuel cash flow. And with management having increase the dividends and share buyback plan, General Mills should now be a central part of a nutritious portfolio.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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