"Your company, and the other major grocers who reaped the benefits of a turbulent 2020, appear to be passing costs on to consumers to preserve your pandemic gains, and even taking advantage of inflation to add greater burdens.... Your companies had a choice: they could have retained lower prices for consumers and properly protected and compensated their workers, or granted massive payouts to top executives and investors.... It is disappointing that you chose not to put your customers and workers first." - Senator Elizabeth Warren's letter to Kroger, Albertsons, and Publix. Unfortunately, the Senator did not stop at "Big Meat" when blaming companies for inflation. Will the grocers be shamed from reporting robust profits?
Got the miss, setting up for outperformance? (GIS)
General Mills reported FQ2 EPS of $.99 vs. consensus expectations of $1.05. Sales growth of 6% was better than expected, but gross margins were 200bps worse. The pressure on gross margins was from “significantly higher input costs.” COGS headwinds are now expected to be $500M or 4% higher than previously anticipated due to input cost inflation of 8-9%. Organic sales growth of 5% with flat volumes resulted in adjusted EPS decline of 7%.
In North America, organic net sales growth was 1% while operating profit declined 8%. In the Pet segment, organic net sales growth was 14% while operating profit increased 10%. Convenience Stores & Foodservice organic net sales growth was 23% driven by a recovery in away-from-home while operating profit increased 20%. Europe & Australia organic net sales decreased 2% while operating profit fell 61% due to higher input costs. Asia & Latin America organic net sales growth was 5% while operating profit increased 40% due to growth in price/mix.
Management is now guiding organic sales growth to be up 4-5% from -1%. Price/mix accelerated from +2% in FQ1 to 5% in FQ2, with further actions being taken in the 2H. At U.S. retail the average unit price increased 9.4% in October and November compared to only 2.5% in June. Strike-related product shortages at the Kellogg Company accelerated share gains for General Mills in US RTE cereal, up 90bps in the 1H.
EPS is now expected to be -2% to +1% from flat. Input cost inflation is expected to be up double digits in the 2H. After getting the negative EPS revision we were modeling we are removing General Mills from our short list. In recent years General Mills has seldomly lowered EPS guidance or missed consensus expectations and we got both in FQ2. General Mills has had strong performance in quad 4s in the past. With re-based expectations and guidance, accelerating price actions, and decelerating input cost inflation the setup would be favorable for outperformance to repeat.
Contract approved; removing from the short list (K)
The Bakery, Confectionary, Tobacco Workers, and Grain Millers International Union members ratified the tentative agreement. Workers had been on strike since early October. The union said the new contract does not include any permanent two-tier system or concessions. Lower-tier employees should be able to graduate to the higher-tier by the end of the five year contract. The company now must restore the workplace morale and catch up production. We are modeling an impact on Kellogg’s Q4 results from the lost production, but expect the Street to look past it. General Mills reported share gains vs. its leading competitor in North American cereal (see comment above). Kellogg’s probably gets a pass for a couple of months on reversing the share losses in the category as production re-accelerates. The results of the strike will encourage unions to negotiate more aggressively in future negotiations.
We are also removing the Kellogg Company from our short list, the timing of the contract approval being coincidental. The corporate image is at a low, a significant distraction should dissipate, and supplies should improve. Quad 4 is the strongest quad for Kellogg's, but it has positive absolute average returns in Quad 1. Our macro team is projecting decelerating commodity costs that would be a tailwind for margins. The company's additional price increases will flow through to retail in the coming months lessening the margin drag.
Our updated position monitor is below:
Return to the office delayed (KR)
According to Kastle Office Systems, the average office occupancy of the top ten cities in the U.S. was 39.5% for the week ended December 15. Door swipes ticked down 30bps from the prior week, as seen in the chart below. The New York metro area had the largest decrease in the past week.
The return to the office will determine how permanent the food consumption shift is from on-premise to off-premise. The return so far has been at a modest pace, but the omicron variant should lead to another drop in occupancy.
