General Mills' Third Quarter Earnings

When Heinz (NYSE:HNZ) drew a premium-priced buyout bid from 3G Capital and Berkshire Hathaway (NYSE:BRK.A, BRK.B), investors got giddy about revaluing the entire packaged food sector. Unfortunately, that looks a bit indiscriminate when it comes to General Mills (NYSE:GIS). While this isn't a bad business per se, nor is it one where a buyer couldn't find some room for improvement - it doesn't have the same sort of brands, market share or international profile. General Mills' fiscal third quarter earnings weren't bad, but the shares are trading in excess of fair value today and don't look like a great holding at these prices.

Some Improvements, but Not Where Investors Want Them
By no means did General Mills have a poor fiscal third quarter. The company logged a four-cent beat on an operating basis, and it looks like the company has seen the worst of its volume erosion.

Revenue rose almost 8% as reported, with organic revenue up 2% (split evenly between price and volume). The U.S. retail business grew about 2% on flat volume, while the international business grew 4% organically on 2% volume growth. The bakery/foodservice business squeaked out a basically flat quarter.

Margins were mixed, but positive overall. Gross margin eroded slightly (down about 2.2 points) and came in below expectation, but operating income improved about 11% and operating margin improved very slightly. I wouldn't worry much about the gross margin shrinkage, as the company switched from consumer advertising (SG&A) to more in-store promotions (COGS).

SEE: Operating Leverage Captures Relationships

Still a Lot of Things to Fix
Looking at the details of General Mills' performance, it actually seems a little surprising that the company did as well as it did. In the critical and much-worried-about yogurt and cereal businesses, the company is still not doing well (with revenue declining 4 and 2%, respectively).

On the cereal side, what may have been previously dismissed as transitory gains by Kellogg (NYSE:K) now look more lasting, and the company has also lost some share to Post Holdings (NYSE:POST). General Mills has historically been pretty good at innovation in this market, but Kellogg seems to be beating them on the new product front, and with the operational improvements at Kellogg, it may be harder to regain that business.

Likewise, the yogurt business is still in tough shape. General Mills has gained back some share in Greek yogurt from Danone (OTC:DANOY) and others, but it seems like the best that can be said about the overall Yoplait business is that it has stopped getting worse.

General Mills has been doing better in areas like soup and frozen doughs, gaining share in both. The former is even more interesting to me, given Campbell Soup's (NYSE:CPB) new product roll-out schedule. At the same time, the dry dinner business has been soft and the company continues to lose share to the likes of Kraft (Nasdaq:KRFT).

SEE: Great Expectations: Forecasting Sales Growth

Average Growth, but Above-Average Expectations
It's worth repeating that General Mills is not a bad company, nor is it performing badly. I'm concerned about the company's share losses in dry dinners and cereal, but the soup and yogurt businesses may be getting better. Likewise, I think the company's investments in building its overseas opportunities will pay off down the line.

Still, I believe we're talking about a 4 to 5% grower here. The company's promotional activities haven't led to robust volume improvements, but then neither has the company sacrificed its margin structure and it is among the most profitable packaged foods companies out there (better than Kellogg and Nestle (OTC:NSRGY)). Better innovation could help regain some share but, outside of Pillsbury, General Mills is not likely to produce those Heinz-like market shares in its key categories.

The Bottom Line
With a 4 to 5% growth rate, General Mills is worth about $45. With the stock trading close to $48 now, that suggests sub-optimal returns for today's buyers, though the dividend yield helps a bit. While I know that the Heinz deal has led some investors to pay more for packaged food stocks, I'd be careful doing the same here – it's a fundamentally different business. It'd take a pullback to closer to $40 to get me interested in this stock, and frankly I'd rather not contemplate the sort of market chaos that would accompany a 15%-plus pullback in the shares of a company like General Mills.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.