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General Mills – Not Wheyed Down

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By: Bob Cramer
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General Mills, Inc. (GIS) has recently seen a fall in the demand for its cereals in the US. However, its Greek yogurt products have shown significant growth. Additionally, the company’s international expansion through business acquisitions and product innovations will remain a catalyst for future growth. The company also pays high dividends, and its strong balance sheet position reflects that it can keep paying dividends in the future and still fund international expansion.

Company Description

General Mills operates in the US packaged foods and meat industry. It is one of the largest morning food and snack companies in the world, with $17.8 billion worth of annual revenues in FY13. The company specializes in the production of cereals, baking products and convenience foods, as well as bakeries and food service. It owns famous brands like Cheerios, Wheaties and Lucky Charms.

General Mills’ Segmentation

The company operates in three segments, namely US Retail, International, and Bakeries and Foodservice. US Retail contributed the most (59.7%) to the total revenues of General Mills in FY13.

*The above figures are rounded off

The company further divides its US Retail segment into seven divisions. Big G, which consists of cereal brands, is the core contributing division; it contributed over 22% to the revenues of the US Retail segment and 13% to the total revenues of General Mills in FY13.

*All the figures are rounded off

Stock Price Shows Consistency

The company’s adjusted EPS (earnings per share) of $0.7 for 1QFY14 was in line with analysts’ estimates. Its stock price performed better than that of its main competitor, Kellogg Company (K), whose stock price fell despite beating analyst estimates. Kellogg’s stock price was down 10% just two months after its earnings were released, while General Mills’ stock price started to recover after falling 3.5% one month after its earnings release.

This is primarily because General Mills has been less affected than Kellogg by maturing cereal demand in the US, and it has lower exposure than Kellogg to the US market for cereals. It also captured Kellogg’s market share through better promotional campaigns. Another major reason was the 100% growth in General Mills’ sales of Greek yogurt products during the quarter (1QFY14).

International Growth is Outpacing the US Market

Although US Retail is the company’s largest segment based on revenues, it has experienced the lowest revenue growth over the last few years. Its revenues grew by just 1.3% annually over the last three years, compared to the International segment and the Bakeries and Foodservice segment, which grew 24.7% and 4% respectively over the same period.

* Compound annual growth rate

The low growth in the US Retail segment was primarily due to a fall in revenues from three of its seven divisions. Revenues from the Big G, Frozen Foods and Yoplait divisions declined 2%, 3.6% and 4.6% respectively during FY13.

The fall in revenues in these divisions was driven mainly by falling demand for cereals in the US. The fall in demand was because of a shift in consumer preference towards more healthy and easy to go food products.

Despite the falling demand, the future for General Mills seems secure, due to its business acquisition initiatives, strong balance sheet and success of product innovations like its Greek yogurt products.

Innovations in Greek Yogurt Proves Successful

The demand for yogurt has risen in the US. As consumers turn towards healthier foods, they now prefer yogurts to cereals for breakfast. This has given an edge to General Mills because it has significant exposure in the yogurt segment.

The company was able to read changing market trends and it capitalized by expanding its yogurt business. For example, its low calorie Yoplait Greek 100 yogurt introduced last year proved to be one of General Mills’ most successful product launches; it generated $150 million in sales revenues in the first year. It launched Yoplait Greek blended yogurt during 1QFY14 in the hope of earning more revenues through further product innovation.

General Mills’ sales for Greek yogurt grew 100% in 1QFY14, compared to a 50% growth for the entire Yogurt division. The company plans to continue innovating through new marketing campaigns and capitalize on the rising demand for Greek yogurt in the US. Its Yoplait segment contributes 12.7% to the total revenues of the US Retail segment.

Expansion into International Markets

General Mills’ International segment has shown the highest growth over the last few years among all other segments. Revenues from international markets have grown 24.7% annually over the last three years. As the US market for cereals reaches maturity, cereal and snack companies have started to expand into international markets for growth. International markets can be a core driver for the future growth of General Mills.

The international acquisitions of Yoki Alimentos S.A. in Brazil and Yoplait in Canada last year have proven successful and are part of the company’s international expansion strategy. The acquisitions caused 6% of the 7% net sales growth of General Mills in FY13.

Although constant currency sales in Europe declined 3% during 1QFY14, General Mills’ new products, such as Häagen-Dazs Secret Sensations chocolate fondants and Old El Paso Mexican Rice kits, showed high growth. The success of new products in Europe, along with the launch of Liberté Greek in the UK, reflects a good future outlook for the company’s European sales. The company has also introduced its high protein Yoplait Yopa! in Canada, Häagen-Dazs in Wan Chai, China, and Yoki Kit Fácil dinner kits in Brazil.

Expected Improvement in Gross Margins

The company’s gross margins declined 4bps (basis points) from FY11 to FY13, following a rise in raw material prices. The average prices of wheat and maize, two primary raw materials for General Mills, increased 28% and 17% respectively over this period.

However, analysts expect an annual expansion in gross margins of 13bps during FY14 and 26bps during FY15, after a fall in raw material prices. Wheat and maize prices have followed this downtrend since the start of the year.

The company has managed the risk of a rise in raw material prices by hedging 60% of its commodity needs for FY14. It aims to improve cost savings through its Holistic Margin Management (HMM) initiative.

Dividend Comparison

General Mills and its predecessor companies have now paid dividends uninterrupted and without reduction for the last 115 years. The company has increased its quarterly dividends for FY14 by 15% compared to an 8% increase in FY13. Furthermore, its last twelve months (LTM) dividend yield of 2.8% is higher than the US 10-year treasury yield of 2.5%.

The company’s dividend coverage improved from 2.1x in FY09 to 3.4x in FY13. Its total debt-to-equity (D/E) ratio of 99% is significantly lower than Kellogg’s 297%. The company’s free cash flows also increased 33.5% to $2.3 billion in FY13.

Note: Last twelve months Dividend coverage is taken for comparison purposes

Moreover, General Mill’s cash balance of $759 million is enough to pay for its $700 million debt obligation which will mature in FY14. The improvement in coverage ratios, free cash flows, and ample cash balance to repay debt make General Mills a dividend stock.

Although the dividend yield is equal to that of Kellogg’s, a higher yield can be expected from General Mills in future due to its better cash balance and coverage ratios. Furthermore, Kellogg’s deteriorating cash flows, high D/E ratio and low cash reserves to pay off maturing debt will impact its ability to pay dividends in future. Such a scenario might push dividend investors to shift their investments from Kellogg to General Mills.

Share Repurchases

The company repurchased over a billion dollars’ worth of shares during FY13. The company reduced its average diluted outstanding shares by 1%, with $298 million in share repurchases in 1QFY14. It plans further repurchases to meet its target of 2% for the complete year (FY14). This can increase EPS growth in FY14 by 2%.

Valuation

General Mills is currently trading at a one-year forward P/E (price-to-earnings) multiple of 16.8x, a little higher compared to its historical five-year average of 15x, and Kellogg’s one-year forward P/E multiple of 15.8x. Analysts estimate General Mills’ earnings will grow 8.8%, higher than Kellogg’s 8%.

To read more about risks associated with buying Kellogg’s stock, read our article “Break your Bowl of Kellogg’s”.

General Mills is currently trading at a premium of only 6% to Kellogg’s one-year P/E multiple. This 6% premium is low, considering General Mills has better future prospects. If General Mills effectively implements its plans, its one-year forward P/E multiple can increase to its five-year high of 17.7x. This would increase its stock price to $56, using FY15 consensus earnings estimates of $3.14.

Conclusion

General Mills’ future seems secure; its new Greek yogurt products are successful and it has expanded into international markets through acquistions. Although the demand for its cereals in the US is maturing, the company is financially strong enough to fund investments for international expansion, which will continue to drive growth.

General Mills’ stable but high dividend yield make it a great dividend stock.

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