General Mills Inc. (GIS, Financial) is a blue-chip stock that has paid uninterrupted dividends for 117 years.
The company’s dividend has increased each year since 2004 and boasts a 10.4% annual growth rate over the last decade.
Despite General Mills’ impressive history, the company’s stock price is down more than 15% since early July 2016 while the S&P 500 Index has gained over 13%.
With investors’ expectations reduced and the stock’s 3.2% dividend yield sitting above its five-year average yield, now is a good time to review why General Mills remains a core holding in our Conservative Retirees dividend portfolio.
Business overview
General Mills went into business in 1866, owning just a single flour mill at the time. Since then, the company has expanded into a number of different industries, including restaurants, toys and even apparel. The company refocused completely on consumer foods in 1995 however.
Today, General Mills sells a diversified mix of packaged meals, cereal, snacks, baking products, yogurt and more. The company’s largest brands are Cheerios, Betty Crocker, Yoplait, Pillsbury, Nature Valley, Old El Paso and Haagen-Dazs. Each of these brands generate over $1 billion in annual sales.
While natural and organic food accounted for about 5% of total revenue last fiscal year, General Mills is the third-largest organic food manufacturer in the U.S. and seeks to increase the size of this business to $1 billion by 2019. Growth will be helped in part by continued expansion of its Annie’s brand (acquired in 2014) into new categories.
By product category, cereal accounted for 20% of sales last fiscal year, snacks 19%, yogurt 16%, convenient meals 16%, ice cream 5%, dough 10%, baking mixes 10%, vegetables 3% and other products contributed 1%.
General Mills primarily sells its products to large retailers such as Wal-Mart (WMT, Financial) (20% of sales), and 72% of its sales last year were made in the U.S. The company has over 600 stock keeping units per store and has been expanding its product categories organically and through acquisitions.
Business Segments
U.S. Retail (61% of sales, 75% of profit): sells meals (24% of U.S. retail sales), cereals (23%), snacks (21%), baking products (19%) and yogurt and other products (13%) to a number of grocery stores, mass merchandisers, dollar stores, natural food chains and other retailers.
International (28% of sales, 13% of profit): consists of retail and foodservice businesses outside the U.S. The product categories are mostly the same as the U.S. retail business. Europe is the largest region at 43% of International segment sales, followed by Asia Pacific (22%), Canada (20%) and Latin America (15%).
Convenience Stores and Foodservice (11% of sales, 12% of profit): General Mills sells its products in this segment through many channels, including foodservice, convenience stores, vending and supermarket bakeries.
Business analysis
General Mills and its predecessors have been around for more than 150 years. Compared to newer companies, General Mills benefits from its scale, long-standing distribution relationships, entrenched brands and decades of marketing spending.
With almost any consumer product, marketing and product innovation are keys to long-term success.
General Mills can outspend smaller players when it comes to marketing campaigns to ensure its products remain in the forefront of consumers’ minds. General Mills spent more than $750 million last year on advertising and media to protect the brand value of its products.
In addition to customer loyalty, these investments help General Mills more easily pass on input cost increases during years of higher commodity prices.
When you start to add up the total dollars General Mills has invested in marketing over the last several decades, it becomes daunting to think about the challenge new food companies face in winning over consumers to their less familiar brands.
This spending has helped General Mills maintain strong market share positions. Most of the company’s brands hold the number one or number two share positions in their categories and have proven to be very resilient over the years.
In ready-to-eat cereal, General Mills enjoys 30% market share. In refrigerated baked goods and grain snacks, market share positions are even higher at 70% and 40% respectively.
Many of the company’s core brands have been on the shelves for decades. For instance, Cheerios and Nature Valley were introduced, respectively, in 1941 and 1975.
Similar to what we noted in our analysis of Kimberly-Clark(KMB, Financial), General Mills’ retail customers also have little incentive to try out products from new competitors as long as General Mills’ products are selling well.
According to Nielsen data, a whopping 85% of consumer packaged goods that launch in the U.S. today will fail within two years. It is no surprise retailers are reluctant to displace mainstay brands.
Given the high failure rate of new products, General Mills’ existing portfolio of successful brands is even more valuable.
The company’s product diversification and financial strength allow it to maintain its lead and continue experimenting. Few companies have the luxury to invest over $220 million in research and development each year like General Mills did during its 2016 fiscal year.
As pointed out earlier, General Mills is also well diversified by product category, with cereal representing its biggest group at 20% of sales last year.
As consumer trends unexpectedly change, General Mills is somewhat hedged by playing in so many different products. When one category changes direction and requires new R&D and marketing investments, another is likely playing to General Mills’ existing strengths.
While the company might be late to catch on to certain consumer trends, its product diversification, financial firepower and distribution relationships ensure it can evolve to remain relevant for years to come.
Introducing Greek yogurt and gluten-free cereals are two examples of recent trends General Mills is following.
The company’s size can cause strategic shifts to take longer to impact overall sales mix however. In these instances, General Mills has not hesitated to acquire its way into faster-growing markets or divest declining businesses to sharpen its focus.
The company announced an agreement to sell its struggling Green Giant brand (frozen vegetables; 4% of total sales) for $765 million in 2015, and it meaningfully extended its reach in the natural and organics space with its $820 million acquisition of Annie’s in 2014.
With U.S. industry sales for natural and organic foods growing at a double-digit rate, it is no surprise General Mills wants to continue growing its share in this category (General Mills claims to be the third-largest natural and organic food manufacturer in the U.S. today).
When General Mills acquires other product lines or develops new products, it also benefits compared to smaller players because it can plug these new products into its global distribution channels to get them selling faster.
For example, the Annie’s business only had 30% national distribution with its top 33 SKUs. General Mills is growing that business’ distribution at a double-digit clip to quickly expand the brand. Annie’s retail sales grew 40% last year.
From a productivity standpoint, General Mills has a company-wide initiative known as Holistic Margin Management (HMM), which it uses to combat the 4% to 5% annual input cost inflation it typically faces.
The initiative relies on productivity savings, mix management and price realization to protect gross margins. It is on track to generate a cumulative $4 billion in savings over the decade ending 2020 and has kept gross margins relatively stable over time.
The company most recently announced a change to its reporting structure, designed to maximize its global scale and drive further efficiencies. Management expects additional savings of $70 million to $90 million by fiscal year 2018, which will help General Mills achieve its goal of improving its operating profit margin to 20% by fiscal 2018 (an improvement of more than 300 basis points since fiscal year 2016).
Altogether, the company’s large market share, entrenched brands, large marketing and R&D budgets, financial flexibility, long-standing distribution relationships, product diversification and continuous cost savings efforts create a strong moat.
As a result, General Mills has maintained a steady double-digit return on invested capital over the last decade:
Source: Simply Safe Dividends
As long as General Mills is able to continue adapting to changing consumer preferences by introducing relevant new products and pursuing appropriate marketing campaigns, the company will likely maintain its strong staying power.
While General Mills’ business will not fade any time soon, profitable growth is no guarantee for such a large company operating in mature markets.
Key risks
General Mills’ sales have declined year-over-year in seven of the last eight quarters. While part of the decline has been driven by the company’s $765 million divestiture of Green Giant in late 2015, many of its core categories have been under attack.
Source: Simply Safe Dividends
Most recently, management reduced fiscal 2017 guidance in February 2017.
Organic sales are now expected to be down 4% for the year, a meaningful decrease compared to management’s initial guidance for full-year sales to be flat to down 2%.
Despite the sales decline, adjusted earnings per share are expected to grow 2% to 4% thanks to continued cost-cutting and share repurchases. Eventually, however, General Mills will need to return to top-line growth.
While ready-to-eat cereal was a primary area of concern several years ago, weakness in General Mills’ yogurt and soup businesses have driven the underperformance this time.
Over the last 20 years, U.S. yogurt sales grew 6% per year, and General Mills’ Yoplait business expanded at the same rate. This business, however, has run into major challenges more recently.
U.S. yogurt sales are down 3% year to date, and General Mills’ yogurt business is off nearly 20%.
Source: General Mills Investor Presentation
While industry conditions are currently tough, General Mills was also late to the Greek yogurt craze and clearly has work to do with its product portfolio.
To illustrate just how fast consumer tastes can change, consider the fact Greek yogurt practically did not exist in grocery stores in the mid-2000s.
In contrast, Greek yogurt accounts for more than one in three yogurt sales today.
General Mills is responding by introducing new and renovated yogurt offerings that better meet consumer needs and investing more in its organic yogurt brands Annie’s and Liberte, which hold an 8% share of the organic yogurt segment.
I believe Yoplait, the number two yogurt brand, will remain relevant and I am willing to give management time to restore this business back to growth over the next year.
Global yogurt retail sales are projected to increase by 8% annually over the next five years, so I think this is an enduring product category that can still be successful.
Predicting its performance any given quarter is impossible due to the fast-moving retail environment, but I like the long-term outlook.
Stepping further back, investors should note that roughly 75% of the company’s sales and operating profits are in product categories that are expected to grow between 3% and 8% per year:
The other 25% of General Mills’ business, which management refers to as “foundation” businesses, is in categories expected to moderately decline over time. These brands include Progresso Soup, Pillsbury refrigerated dough and Betty Crocker desserts.
Management entered fiscal year 2017 expecting the company’s growth businesses (75% of sales) to expand at a low single-digit organic rate and its foundation businesses to decline at a mid-single-digit rate.
Last quarter, however, General Mills’ growth and foundation businesses were down 3% and 8% respectively.
Yogurt was obviously disappointing, but cereal, baking products and meals were also down Ă‚ 3%, 7% and 17%.
Part of the challenge has been a broad slump in food and beverage retail sales growth, which has made the competitive environment even more challenging. Target (TGT, Financial) and Wal-Mart also recently announced more price cuts, which will not help the environment either.
General Mills’ sales results are still noticeably worse than the industry’s however. There are several reasons for this.
First, consumers are increasingly concerned with what they eat. They want natural, healthier foods that contain more protein, fiber and whole grains rather than gluten, carbs and artificial ingredients.
This has opened the door for new food companies to launch healthier brands and chip away at the high market share positions enjoyed by packaged food giants that have missed the health trend in many categories.
General Mills is slowly but surely responding to this trend. All of the company’s cereals will now be free of high fructose corn syrup, artificial colors and artificial flavors this year. It also launched a gluten-free version of Cheerios in the fall of 2015.
It is hard to say if the company can truly change consumers’ perception of some of its old brands. There are also several legacy brands that just do not seem to have many options to combat the healthier eating trend (e.g. Betty Crocker desserts).
General Mills is also working hard to expand more into natural and organic products, which account for less than 10% of sales today but have grown at a high single-digit annual rate in recent years. Management is expanding Annie’s organic brand into new product categories such as yogurt, soup and cereal.
There is risk, however, that General Mills will mismanage its organic products since that area has not historically been a core competency of the company.
Finally, the company’s disappointing sales growth is partly the result of mismanagement. General Mills has been aggressively cutting costs to keep earnings growing, and it sounds like it has cut too far in some product lines:
“As we look back at the first quarter, we think there are cases where we cut too far or reduced spending too much in certain areas, so we’re going to add back and correct as we go forward in the second half.”
Overall, sales growth has been disappointing due to a combination of factors – a soft food and beverage retail environment, the continued shift to healthier foods and excessive cost-cutting by management.
None of these factors will be fixed overnight, but the diversity of General Mills’ product portfolio and the company’s vast financial resources position it well to survive and eventually adapt. New product launches and refocused marketing spending will help the company stay relevant, and its dividend remains extremely safe.
Dividend safety
We analyze 25-plus years of dividend data and over 10 years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with companies that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been and how to use them for your portfolio here.
General Mills has an excellent Dividend Safety Score of 95, suggesting its current dividend payment is one of the safest in the market. The company’s reasonable payout ratios, strong free cash flow generation, recession-proof products and wide moat support the favorable ranking.
Over the last 12 months, General Mills’ dividend has consumed 71% of the company’s earnings and 67% of its free cash flow per share. For a stable business like packaged foods, these are safe payout ratios.
Over the long term, General Mills’ payout ratios have been pretty consistent in the 40% to 60% range, providing plenty of safety and room for continued dividend growth even if earnings growth temporarily struggles.
Source: Simply Safe Dividends
Source: Simply Safe Dividends
The company’s strong Dividend Safety Score is also supported by General Mills’ performance during the last recession. The company’s reported sales actually grew every year during the financial crisis and free cash flow remained stable. Consumers still need to eat during tough economic conditions, and it is cheaper to cook at home rather than eat out.
Source: Simply Safe Dividends
General Mills’ dividend is also supported by the company’s consistent free cash flow generation. Free cash flow is the source of sustainable dividend growth. You can see that General Mills has generated very consistent free cash flow for more than a decade.
Source: Simply Safe Dividends
The only knock against General Mills’ dividend safety is its balance sheet. Companies will always make their debt payments before declaring dividends, so it is very important to understand if a business has too much financial leverage.
General Mills’ debt to capital ratio has increased over the last decade to 57% last fiscal year. I usually prefer companies to keep their debt to capital ratio no higher than 50%, but companies with more predictable cash flows and recession-resistant products such as General Mills can comfortably extend a reasonable amount beyond that mark.
Source: Simply Safe Dividends
Despite its relatively high debt burden, General Mills maintains an investment-grade credit rating with S&P and should not have any trouble servicing its debt. The company has over $3 billion available in its credit facilities as well.
Overall, General Mill’s dividend is extremely safe thanks to its reasonable payout ratios, stable earnings and excellent free cash flow generation.
Dividend growth
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score, but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good and 25 or lower is considered weak.
General Mills’ Dividend Growth Score is 54, indicating the company’s dividend growth potential is about average.
While General Mills is surprisingly not yet on the list of dividend aristocrats , the company and its predecessors have paid dividends without interruption or reduction for 117 years, an amazing accomplishment.
Management has raised the dividend every year since 2004, recording 9.7% annual dividend growth over the last five years. The company last raised its dividend by 7% in June 2016.
Source: Simply Safe Dividends
Looking ahead, General Mills’ dividend is expected to grow in line with the company’s underlying earnings growth. If General Mills’ earnings can grow at management’s objective in the high single-digits, the company’s annual dividend growth will likely remain in the 6% to 9% range as well.
I would not be surprised by a more moderate dividend increase this year given the company’s growth struggles. However, dividend growth should still continue outpacing inflation.
Valuation
General Mills’ stock trades at a forward price-earnings (P/E) multiple of 19.8, which is a slight discount compared to the forward P/E multiple of 20.3 the S&P 500 Consumer Staples sector trades at.
Shares of General Mills also offer a dividend yield of 3.2%, which is above the stock’s five-year average dividend yield of 2.95%.
Considering the company’s stable earnings profile and overall quality, General Mills’ stock appears to be reasonably priced if the business can return to organic sales growth in the coming years.
Management believes the company can generate low single-digit sales growth and high single-digit diluted EPS growth over time.
If General Mills can indeed grow its earnings by 6% to 9% per year over the long run, its stock offers annual total return potential of 9% to 12% (3.2% dividend yield plus 6% to 9% annual earnings growth).
While the competitive environment is fierce and consumer trends are certainly changing, I do believe General Mills will return to organic sales growth.
Roughly 75% of the company’s sales are in global categories that are growing between 3% to 8% per year, and management has the financial resources and brands needed to protect market share and evolve its offerings to stay relevant.
Conclusion
The sales growth challenges facing General Mills could persist for another few quarters or perhaps even longer as the packaged food industry continues experiencing meaningful change.
General Mills seems to possess the necessary resources needed to stay relevant with consumers over the long term however.
I believe the company’s marketing budget, R&D investments, shelf space, distribution relationships, financial strength, product diversity and powerful brands will help it play catch-up with the latest consumer trends.
With a very safe, growing dividend and a reasonable valuation, General Mills is an attractive holding as part of a diversified dividend portfolio, especially for conservative investors living off dividends in retirement.
Disclosure: The author is long General Mills.
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