Stock prices decline for a number of reasons. Typically, a sharp decline in share price happens because a company’s fundamentals are deteriorating. However, sometimes a stock decline is not entirely justified. A temporary slowdown might cause investor sentiment to erode, but the long-term potential of the company could still be intact. In these cases, a falling share price could actually represent a buying opportunity.
Food and beverage giant General Mills (GIS) has had a rough year. The stock has declined by approximately 27% so far in 2018. Some of its core brands have experienced slowing growth, as consumer preferences are shifting, which has investors worried about its future prospects. If all that weren’t bad enough, the food and beverage industry as a whole is facing higher raw materials costs due to inflation.
However, General Mills has a long history of navigating difficult times. The company still has many category-leading brands, and a huge recent acquisition gave it access to a major new growth category. In the meantime, the stock price decline has made shares cheap, with a 4.5% dividend yield that pays investors well to be patient.
Business Overview & Recent Events
General Mills traces its roots to the 1860’s and a small flour mill in Minnesota. In the 150+ years since, General Mills has grown into a massive food and beverage company, with annual sales of nearly $16 billion. The company’s core products include cereal, flour, baking products, and prepared meals. Its major brands are Cheerios, Wheaties, Gold Medal, Betty Crocker, Pillsbury, Yoplait, and Nature Valley.
This is not an easy time for General Mills. Slowing sales of some of its core brands, cereal and yogurt in particular, have weighed the company down over the past year. These challenges were evident in General Mills’ financial performance in fiscal 2018. Organic sales and adjusted earnings-per-share were both flat for the year. U.S. yogurt sales declined by 12% for the full fiscal year.
Conditions remained weak in the fiscal 2019 first quarter. Organic sales increased modestly according to the company, while earnings-per-share were again flat. Net sales declined 2% each in U.S. Meals & Baking and U.S. Yogurt. General Mills’ adjusted gross margin, declined by 160 basis points to 33.6%, driven by input cost inflation.
At the root of General Mills’ weak performance is that industry trends are changing in the United States. Consumers are shifting away from packaged foods and prepared meals. In addition, consumers are eating less cereal, a core category for General Mills. Instead, consumers are increasingly purchasing fresh foods, as well as natural and organic products. As a result, a variety of companies that sell their products mainly in the middle aisles of the grocery store are experiencing sluggish sales.
In addition, costs are rising for food and beverage manufacturers. Rising commodity prices and inflation threaten to erode profit margins across the industry. Consumer goods companies face the difficult choice of absorbing the hit to margins, or passing those higher costs onto consumers through higher prices.
In response to these various headwinds, General Mills has launched a turnaround with two core principles. First, the company is turning to acquisitions to expand into new product categories. Second, General Mills is cutting costs across the business to help protect profit margins from the impact of raw materials inflation. These initiatives take time, and require investors to be patient, but General Mills is on its way back to growth.
General Mills’ biggest growth initiative is its $8 billion acquisition of Blue Buffalo. This huge deal gave General Mills access to the large-and-growing pet food market, a $30 billion industry that has grown at a 5% annual rate over the past 10 years.
Source: Acquisition Presentation, page 5
General Mills has also expanded into organics, with the $820 million acquisition of Annie’s in 2014. General Mills expects its natural and organics portfolio to reach $1 billion in sales next year. General Mills’ new pet segment is going to be a major driver of future growth. Last quarter, net sales for the Pet segment totaled $343 million, a 14% increase from the same quarter last year. Positive contributions came from volume growth as well as price increases.
The emerging markets are also a growth catalyst for General Mills. For example, General Mills has a growing presence in China and India, two of the most attractive emerging markets in the world. These regions have large populations and high economic growth rate, making them very appealing areas of expansion for U.S. consumer products companies. Last quarter, General Mills’ organic sales in Asia & Latin America increased 8%, led by Häagen-Dazs ice cream, Wanchai Ferry frozen dumplings, Yoki and Kitano meals and snacks, and Pillsbury snack bars.
The upcoming year will remain challenging for General Mills. Company management expects organic sales to be flat to up 1% for the year, while adjusted earnings-per-share are expected to be flat, to down 3%. However, these catalysts should fuel General Mills’ long-term growth, as the company adapts to a changing environment. In the meantime, investors are paid well to wait for the turnaround to gain traction.
100+ Years Of Dividends
Perhaps the most attractive aspect of buying stock in General Mills is its dividend, which currently yields 4.5% thanks to its falling share price. The company has increased its dividend for over 10 years in a row and has paid dividends for 118 years. In addition, General Mills stock appears to be undervalued, which means investors buying in at the current price could earn strong returns over the next several years. General Mills stock has a price-to-earnings ratio of 14.3, compared with a fair value estimate of 16.9, which is the 10-year average valuation for the stock.
If General Mills shares trade up to its historical average, the expanding valuation multiple would add approximately 3.4% to annual returns. In addition, earnings growth and dividends will generate returns for shareholders. Earnings-per-share are expected to increase by 3.2% per year over the next five years, which is a reasonable estimate for General Mills. The combination of valuation changes, dividends, and earnings growth could generate total returns of 11%+ each year over the next five years.
Turnarounds don’t happen overnight, particularly for large, century-old companies like General Mills. But with a renewed focus on cost cuts, investment in growth categories such as snacks and ice cream, and the Blue Buffalo acquisition, General Mills has a clear path for a return to growth. Until then, investors can use the decline in the share price as a buying opportunity. With expected returns of 11% per year and a 4.5% dividend, General Mills is an attractive stock for value and income investors.