One of the most important things to pay attention to in an inflationary environment is what happens to volume growth once a consumer packaged goods company significantly increases its end market prices in order to offset its own inflationary costs inputs. Usually, volumes go down and a company sells less product when it raises prices, unless there is a corresponding increase in wages across the board. One of the most recent companies to prove that consumers can no longer keep up with inflation is General Mills Inc. (GIS, Financial), a large American packaged food company. This could spell trouble for shareholders of General Mills.
The company produces cheap and easy-to-eat foods like ready-to-eat cereals, yogurt, soup, meal kits, dough products, dessert and baking mixes, snacks, etc. It also has a commercial foodservice division which provides products to restaurants and hospitality customers. The company has some of the top food brands in North American, including Annie’s, Betty Crocker, Bisquick, Cheerios and Pillsbury. General Mills was founded in 1866 and currently has a market capitalization of $50 billion as of this writing.
Market share growth
General Mills continues grow its market share in many important categories and in some cases maintains a dominant market share position. In ready-to-eat cereal, the company has a U.S. dollar-based market share of 34.4%, which is up from 30.5% in 2017 with brands such as Cheerios and Cinnamon Toast Crunch leading the way. In the refrigerated dough category, the company’s dollar market share is 73.2%, which is up from 66.8% in 2018. This includes products such as Pillsbury Crescent Rolls and Pillsbury Cookie Dough.
The fruit snack category, which includes products such as Motts Fruit Flavored Snacks and Tropicana Fruit Gushers, has also been a recent strong performer with market share increasing to 51.1% from 48.8% four years ago. The pet business, which includes the Blue Buffalo brand name, has been a strong performer since it was acquired in 2018. Sales have increased from $1.3 billion at the time of the acquisition to $2.3 billion in the latest fiscal year. According to NielsenIQ, Blue Buffalo is the #1 pet food brand in the U.S.
Financial review
For the company's fiscal second quarter ending Nov. 27, 2022, it reported organic revenue growth of 11%, which was comprised of price increases of 17% and volume declines of 6.0%. Operating income increased 10% as strong price realization in the North American retail segment offset losses in the pet and international segment.
The balance sheet at quarter's end showed cash and equivalents of $644 million and total debt of $10.6 billion. Operating cash flow totaled $1.2 billion for the six month period ending November 2022 and capital expenditures were $227 million. Dividend payments increased 4.0% to $648 million for the quarter and share repurchases increased to $901 million from $375 million a year ago.
General Mills' CEO stated:
“We continued to execute well and delivered strong top and bottom-line growth in the second quarter. Amid ongoing volatility in the operating environment, we remain focused on driving our Accelerate strategy by investing in brand building and innovation, strengthening our capabilities, and continuing to reshape our portfolio. With strong first-half results and positive momentum on our business, we are increasing our full-year outlook for organic net sales, adjusted operating profit, and adjusted diluted EPS growth.”
Valuation
The company updated its fiscal 2023 financial targets and now calls for organic net sales to increase 8% to 9%, which compares favorably to previous expectation of 6% to 7% growth. Adjusted operating profit is expected to increase 3% to 5% on a constant currency basis and adjusted diluted EPS is expected to increase 4% to 6%. High levels of price increases are not expected to be enough to offset inflationary input costs and supply chain issues.
Consensus analyst EPS estimates for the fiscal year ending May 2023 are $4.13. For the fiscal year ending May 2024, the estimate is $4.36. The enterprise-value-to-Ebitda ratio is expected to be in the 15 to 16 range. These elevated multiples reflect the company’s consumer staple product lineup and its ability to pass on price increases and still generate positive organic revenue growth.
The GuruFocus discounted cash flow (DCF) calculator gives a fair value estimate of approximately $68 when using a $4.13 earnings per share starting point and estimating an 8.0% long-term earnings growth rate. That growth rate estimate is generous when considering consumer staples as an industry are typically mature, low growth companies.
General Mills has paid a dividend for many decades and the current annualized dividend payment is $2.16, which equates to a 2.60% dividend yield.
Guru trades
Gurus who have purchased General Mills stock recently include Joel Greenblatt (Trades, Portfolio) and John Hussman (Trades, Portfolio). Gurus who have reduced or sold out of their positions include Ray Dalio (Trades, Portfolio) and Jim Simons (Trades, Portfolio).
Summary
General Mills has managed top-line growth this year, but it is still a risky stock at these levels given the market environment and lower volume. Consumers can only take so many price increases as there would be a tipping point where volumes could plummet. Although some believe the company’s growth prospects are better than other packaged food peers, recession fears mean the stock doesn't deserve a high multiple at this time. Further, private label trade downs could accelerate as branded products continue to increase prices.
