General Mills Seeing Good OUS Growth, But Yoplait Needs Help

By Stephen D. Simpson, CFA | September 20, 2012 AAA

It's always something with Wall Street analysts and investors. So although General Mills (NYSE:GIS) is doing all right in businesses such soup and baked goods, and management seems pretty confident that the drought won't hurt margins much, worries about the Yoplait yogurt business overshadow good growth in overseas markets. While General Mills may not be a bad option for long-term income-inclined investors, it's hard to work up a lot of excitement on the basis of today's valuation.

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Fiscal Quarter One Came in Basically as Expected
General Mills did basically as expected this quarter, though that performance didn't necessarily come as expected.

Revenue rose 5%, more or less in line with expectations, as very strong overseas growth (up 36% in constant currency, 27% in reported terms) offset softness in U.S. retail and bakery sales (down about 1 and 2%, respectively). On an organic basis, sales were down 2% as volume was flat on a 2% price decline, fueled by promotional activities. Although comparisons can be dangerous, it has to be a little disappointing to see the relatively better price-volume trade-off at Kellogg (NYSE:K).

Profitability was OK. Gross margin did pull back about 40 basis points on an adjusted basis, while operating income rose a little less than 5% (also on an adjusted basis). U.S. retail operating income fell almost 2% this quarter, while bakeries saw 10% growth and international operating income jumped 56%. It's worth noting that although international sales are growing well for General Mills, the growth comes with margins almost half those of the U.S. retail business.

SEE: Understanding the Income Statement

Yogurt Still off its Stride
It looks and sounds like General Mills is doing relatively well in soup compared to Campbell Soup (NYSE:CPB), given that Campbell's recent results were likely boosted by buy-ins ahead of announced price increases. The cereal business is more stagnant, though I would think General Mills' history of innovation (including moving aggressively on gluten-free and whole grain products) would be more of a help.

Yogurt, though, is in trouble. I'm not sure I'd go as far as a Credit Suisse analyst who said that the Yoplait business is "in crisis," but it's pretty clear that privately-held Chobani and Danone (OTC:DANOY) are doing something that General Mills isn't. Improving the U.S. yogurt business has been an area of major focus for General Mills, and I would think that a lot of promotional activity, product support and attention from management are going to go to this business.

International Investments Should Pay off Eventually
Although General Mills' current margins from international sales aren't stellar, this is still very much a business worth building. General Mills may lag behind Kellogg in global share, but the company has carved out lucrative positions in emerging markets such as the Philippines, Indonesia, Turkey, Thailand, China and Russia.

But there's work to do. General Mills' business in China has been built so far around Haagen-Dazs, Wanchai Ferry and Bugles, but difficulties in securing a high-quality dairy supply have been a constraint. In India, the issue has been distribution (not an uncommon problem), while General Mills' focus on Indonesia has really only just begun. These are all fixable issues; the question and challenge for management is which projects to prioritize and determining the right balance between investing for tomorrow's growth and preserving today's margins and capital returns to shareholders.

SEE: Globalization: Progress or Profiteering

The Bottom Line
I think General Mills is a decent enough choice in the food sector, though I'd prefer Kellogg or maybe even Nestle (OTC:NSRGY) at current prices. General Mills has multiple solid brands (Progresso, Pillsbury, Yoplait, etc.) and good international growth prospects, but the company does need to show more dynamism in cereal, snack bars and yogurts to really unlock more value.

General Mills looks fairly valued on the assumption of 4 to 5% compound annual free cash flow growth for the next decade. A 3.5% dividend yield makes it a solid enough candidate for long-term income portfolios, but there's not much slack left in today's price.

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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