(Published by Nick McCullum on July 10)
The consumer staples industry has a compelling value proposition for conservative investors.
Why is this?
The consumer staples sector has historically been one of the best-performing sectors of the stock market while also having the best recession performance.
Traditional financial theory suggests that additional risk must be assumed to generate excess returns. The outperformance of the consumer staples sector indicates that this is not necessarily true.
General Mills (GIS, Financial) is one of the most well-known consumer staples stocks. Furthermore, it is also one of the "bluest" blue-chip stocks around. This Blue Chip Stocks Excel Sheet contains pertinent information on all blue chip stocks with 100-year-plus operating histories and 3%-plus dividend yields.
General Mills has a very long operating history, having been founded in 1928.
Further, the company and its predecessors have paid dividends without interruption for 117 years, and its current dividend yield is 3.7%.
In fact, General Mills is a member of the Dividend Achievers, an elite group of stocks with 10-plus years of consecutive dividend increases. The Dividend Achievers Excel Sheet contains useful financial information for this elite group of dividend stocks.
General Mills’ very high dividend yield, long corporate history and strong dividend history make it stand out to long-term investors.
This article will analyze the investment prospects of General Mills in detail.
Business overview
General Mills was founded more than 150 years ago as a single flour mill in Minnesota.
Since then, the company has grown into a global food and beverage giant, selling more than 100 brands in 100-plus countries.
General Mills operates in four main segments:
- U.S. Retail ($10.0 billion of 2017 revenue).
- International ($4.6 billion of 2017 revenue).
- Convenience Stores and Foodservice ($1.9 billion of 2017 revenue).
- Joint Ventures ($1.0 billion of 2017 revenue).
More details about each operating segment can be seen below.
Source: General Mills Web site
In the introduction to this article, I noted that the consumer staples sector has a long history of delivering outsized shareholder returns.
General Mills is no exception in this regard. The company has outperformed the Standard & Poor's 500 over most meaningful long-term time periods.
Source: General Mills 2017 CAGNY Presentation, slide 6
Current events
General Mills recently reported earnings for the fourth quarter of its fiscal 2017. Because of the structure of General Mills’ financial calendar, the company’s fiscal 2017 ended on May 28.
Its financial performance continued a long-term trend for General Mills. The company grew earnings per share at a favorable rate, but net sales actually decreased.
More specifically, General Mills’ fourth-quarter 2017 saw adjusted diluted earnings per share increase by 14% while net sales declined by 3%.
More details about General Mills’ fourth-quarter financial performance can be seen below.
Source: General Mills Fourth Quarter Earnings Presentation, slide 9
Looking more broadly, the same trend of stagnant revenue offset by margin expansion held true for General Mills’ full-year 2017.
The company saw net sales decline by 6% while adjusted diluted earnings per share increased by 6% on a constant-currency basis.
Source: General Mills Fourth Quarter Earnings Presentation, slide 11
So what has caused General Mills’ poor revenue performance?
It is a combination of changing consumer tastes and the strength of the U.S. dollar. Some of General Mills’ most important brands (notably cereals) are experiencing declining demand while its international revenues have been less valuable when swapped back to dollars since the dollar is so strong right now.
While this is a worrying trend (after all, there is a limit to how much earnings growth can be achieved through margin improvements), it appears that the issues causing General Mills’ poor revenue performance are short-lived. Investors should view the company’s price action as a buying opportunity.
Growth prospects
General Mills has been unable to deliver consistent top-line growth for some time now. Net sales declined 6% in fiscal 2017, or 4% on a constant-currency basis.
This revenue stagnation has led the company to fall out of favor with its investor base making it appealing for contrarian investors.
“The time to get interested is when no one else is. You can’t buy what is popular and do well.” – Warren Buffett
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Fortunately, General Mills has a nice mix of compelling growth opportunities that should allow it to return to top-line growth moving forward.
The most notable is e-commerce.
While General Mills itself is not an e-commerce company, it is forming strong relationships with leading e-commerce retailers to boost its sales through this growing distribution channel.
Source: General Mills Fourth Quarter Earnings Presentation, slide 37
The company is also expecting margins to continue expanding in the near term.
General Mills has expanded its adjusted operating margin from 15.9% to 18.1% over the past three fiscal years (2015 to 2017). Looking ahead, 2018 is expected to be another year of expansion.
With that said, there is a limit to how much earnings growth can be generated through margin expansion. General Mills is aiming to balance sales growth and margin expansion over the long term.
Source: General Mills Fourth Quarter Earnings Presentation, slide 7
Competitive advantage and recession performance
General Mills’ most important competitive advantage comes from its impressive brand portfolio.
The company owns many household brand names including Cheerios, Pillsbury, Nature Valley and Fiber One. Some of General Mills’ most important brands can be seen below.
Source: General Mills Investor Fact Sheet
General Mills also benefits from having a very diversified business model.
The company generates revenue from a healthy mix of different food categories, shown below.
Source: General Mills Investor Fact Sheet
General Mills is a recession-resistant business.
Intuitively, this makes sense. The company produces food, one of the last expenditures to be cut when a consumer’s disposable income becomes constrained. Thus, one would expect this company to be insulated from the effects of a recession.
History supports this thesis. General Mills managed to increase its adjusted earnings per share during each year of the 2008-2009 financial crisis. The company’s adjusted earnings per share during that period can be seen below.
- 2007 adjusted earnings per share: $1.59.
- 2008 adjusted earnings per share: $1.76 (10.7% increase).
- 2009 adjusted earnings per share: $1.99 (13.1% increase).
- 2010 adjusted earnings per share: $2.30 (15.6% increase).
The company thrived during the last recession. Looking further back, General Mills has actually increased its adjusted earnings per share each year since 2005, showing the resilience of its business.
General Mills’ necessity-based business model and strong historical recession performance mean that this company is likely to outperform the market during future economic downturns.
Valuation and expected total returns
As with any company, General Mills’ expected total returns can be broken down into valuation changes, dividend yield and growth in the company’s earnings per share.
General Mills reported adjusted diluted earnings per share of $3.08 in its recently completed fiscal 2017. The company’s current stock price is $53.63. Some quick math tells us that General Mills is trading at a price-earnings (P/E) ratio of 17.4 using 2017 earnings.
Looking ahead, General Mills is expected to report adjusted earnings per share of about $3.25 in fiscal 2018 (which concludes in the middle of calendar 2018). Using 2018’s expected earnings, General Mills is trading at a forward P/E ratio of 16.5.
The following diagram compares General Mills’ current valuation to its long-term historical average.
Source: Value Line
General Mills’ average P/E ratio since 2001 is 17.4, equal to its current P/E ratio (using 2017’s earnings).
The company is trading very close to fair value. Buying high-quality businesses at or near fair value and holding them for the long run is a fantastic way to build long-term wealth.
General Mills’ total returns will receive a significant boost from the company’s above-average dividend yield.
The company currently pays a quarterly dividend of 49 cents per share which yields 3.7% on its current stock price of $53.63.
General Mills’ dividend yield is nearly twice as high as the average dividend yield in the S&P 500 – 1.9%. Accordingly, this stock holds appeal for retirees and other varieties of income investors.
The remainder of General Mills’ total returns will be composed of the company’s growth in earnings per share.
Since 2001, General Mills has compounded its bottom line from $1.10 to $3.08, a CAGR of 6.6% per year. The company’s detailed earnings-per-share history over the past 15 years can be seen below.
Source: Value Line
Looking ahead, it is perfectly reasonable for this stock to deliver annual earnings-per-share growth of 5% to 7% over full economic cycles.
To sum up, General Mills’ expected total returns are composed of
- 3.7% dividend yield.
- 5% to 7% annual growth in adjusted earnings per share.
For expected total returns of 8.7% to 10.7% before the (likely minimal) impact of valuation changes.
Final thoughts
On the surface, General Mills has many of the characteristics of an attractive investment: a high dividend yield, long corporate history and a durable "blue-chip stock" reputation.
Digging more deeply reveals that the company is trading at a fair valuation and experiencing some temporary market pessimism due to its inability to grow revenue in recent years.
All said, it appears that General Mills’ troubles are temporary, and its recent stock price decline is presenting a compelling buying opportunity for long-term investors.
Disclosure: I am not long the stock mentioned in this article.
