Takeaway: All-in-all fiscal year 2015 was a year of change and self-reflection for GIS and I believe they are better off for it.
General Mills capped off its 2015 fiscal year this past weekend, and will be set to report 4Q FY15 EPS on July 1, 2015. GIS in on the HEDGEYE Best Ideas list as a LONG. In this note we will summarize the year and tell you why we are still very confident in the name.
We see multiple ways you can win being LONG GIS:
1. The current management transforms into an Activist management team - 15% chance
2. Fundamentally – Gluten Free Cheerios is a home run – 40% chance
3. Management sells the company – 10% chance
4. An Activist shareholder takes a position – 35% chance
Please note above our increased faith in management to be able to fundamentally improve the business.
Management needs to start focusing on their non-core assets that represent roughly 28% of the portfolio such as, Pillsbury, Gold Medal, Green Giant and Progresso. Divesting these brands would free up resources and provide greater capital to acquire a strong high growth business.
GIS is a company known for great brands, and consumers are proving that once again. GIS is growing share in key categories this year with grain snacks dollar share up 187 basis points (bps) vs last year, yogurt up 75 bps and ready-to-eat (RTE) cereal up 31 bps. GIS is often a leader in the categories in which they compete and they are showing their strength.
Selling the company is an option, albeit an unlikely one given the current valuation. If the price were to slip a little, some big players in the market would take a harder look at it. This is also the case for an activist coming on board, for someone willing to put in the work there is still plenty of meat on the bone, but most would probably want to see a pullback in the stock before taking a major position.
All-in-all this stock is built for growth and with it currently paying a generous 3.1% dividend, that has never been decreased or interrupted, it is a worthwhile bet that this ship will turn.
FY15 AT A GLANCE
It was a rough 1H FY15 for GIS, lowering its earnings and sales guidance in November 2014, because of continued weak food industry trends in the U.S. coupled by slow growth in key markets internationally. 2H FY15 has showed glimmers of hope, growing share/sales in key categories such as grain snacks, yogurt and RTE cereal and the continued strong performance of the Convenience Stores & Foodservice (C&F) segment as a whole.
FY15 was also a year of change for GIS. Management is working through a major restructuring program and completed the $820 million acquisition of Annie’s. We believe that management took a massive step forward this year and have acknowledged their mistakes of the past. That being said, we believe that GIS could see another round of restructuring and would benefit from repositioning of its branded portfolio.
First Quarter Fiscal Year 2015
QUOTE FROM KEN POWELL, “Back in June, we said our 2015 plans anticipated first-quarter EPS below year-ago levels. Our results were driven by sales and profit declines in the U.S., where industry trends were weak in the quarter. In addition, higher merchandising expense for our U.S. Retail businesses in this period depressed reported net sales and gross margin.”
Net sales for the total business declined 2% in 1Q FY15. Pound volume subtracted 2 points of growth, price realization and mix contributed 1 point of net sales growth, while foreign exchange subtracted 1 point of growth. Disappointingly, gross margin was below year-ago levels reflecting the lower net sales and product mix.
The U.S. Retail segment posted a disappointing 5% decline versus last year. Not all was bad, management stated that Snacks, Yoplait and Small Planet Foods all posted gains in the quarter. On the other hand, Meals and Baking Products had declining pound volume. Poor execution on some of the 145 new products that were launched in the quarter led to higher costs. The new products introduced were 20% above last year’s number causing higher merchandising cost, which ended up being less effective coupled by a tough comp to last year.
International started the year off strong and provided signs of hope in the quarter. Brazil experienced double digit growth coupled by strong performance in key European markets UK and France.
Management made the big announcement to the beginning of the restructuring which was Project Century, which at the time they were projecting $100 million in savings.
NET SALES GROWTH BY SEGMENT VERSUS LAST YEAR
Second Quarter Fiscal Year 2015
QUOTE FROM KEN POWELL, “Second-quarter results were broadly in line with the updated outlook we provided in early November. Net sales declined for the quarter as anticipated, reflecting continued weak food-industry trends in the U.S. and slowing growth in key emerging markets. Adjusted diluted EPS came in slightly better than our estimate, primarily due to differences in expense timing. These quarterly results keep us on track to achieve the full-year fiscal 2015 targets announced last month.”
Net sales for the total business declined 3% in 2Q FY15, including 1 point of growth contributed by the Annie’s acquisition. Actual pound volume was down 2% vs year-ago levels, while net price realization and mix added 1 point of net sales growth.
Management made some major announcements centered on the cost savings initiatives, Project Century, Project Catalyst and Policy & Practices Update. Taken together, these projects are all meant to reorganize the business and right size expenses. Total savings from the projects are expected to be more than $350mm by FY17. As part of Project Catalyst the U.S. Retail segment re-aligned its operating segments into five categories, Snacks, Yogurt, Cereal, Baking Products and Meals, designed to better serve the retailers and the consumers. Wall Street was worried/confused about the collapse of Small Planet Foods into multiple other divisions but to alleviate the concern GIS established a natural and organic marketing center of excellence to focus on those key brands.
The company continues to be focused on growth through innovation, marketing and listening to the consumers. Yet, this focus has not manifested into substantial volume growth for the company. Yoplait yogurt continues to gain share in the Greek segment, up 300 basis points versus 2Q FY14, and Yoplait Original is picking up steam as well. The cereal category is one of the biggest battle grounds within the center-of-store, the category has been faced with declines, and so stealing share is the only way to gain. GIS has continued to do this, picking up 60 basis points of dollar share in this quarter. Looking out to FY16, the launch of Gluten-Free Cheerios could drive incremental market share gains.
Strong snacks momentum, Grain Snacks FYTD retail sales are up 5%, Fruit Snacks up 4% and Natural/Organic Snacks are up 18%, all led by innovation. Lastly, GIS completed the acquisition of Annie’s for $820 million and although it only contributed nine days of results to this current quarter, management is very excited about the potential this brand brings to the portfolio.
NET SALES GROWTH BY SEGMENT VERSUS LAST YEAR
Third Quarter Fiscal Year 2015
QUOTE FROM KEN POWELL, “Our third-quarter results reflected strengthened operating performance. Our U.S. Retail segment posted net sales and profit growth including contributions from the Annie’s business acquired in October 2014. Constant-currency net sales and profit growth accelerated for our International segment. And the Convenience Stores and Foodservice segment led our operating results, with sales up 6 percent and profit up 11 percent.”
In 3Q FY15 net sales for the total business grew 3%, including 1 point of growth contributed by the Annie’s acquisition. Actual pound volume was down 1% vs year-ago levels, while net price realization and mix added 4 points of net sales growth. The performance of the cereal category in 3Q FY15 supports our belief that GIS can improve its performance in the cereal category by rationalizing lagging brands.
The Convenience Stores & Foodservice (C&F) segment continues to be a focus for management as they highlighted in the Q3 earnings call. As we highlighted in our GIS Black Book, the C&F business has been transformed over the last 10 years, by shrinking the sku count and manufacturing locations as well as switching to a direct salesforce. In addition they divested non-core businesses such as, bread concentrate, frozen bread dough, bread crumbs and frozen pie shells. When we see these actions creating such positive results we know that similar actions across the broader GIS portfolio will yield similar results.
NET SALES GROWTH BY SEGMENT VERSUS LAST YEAR
REVIEW OF GIS’S FIVE GLOBAL PLATFORMS
Cereal is not dead, it has merely reached a point of maturity, and it’s up to manufacturers to reinvigorate the category through innovation. As seen in the chart below, it has been a rough last three years for cereal, but we seem to be turning a corner as seen in the last 52-weeks period.
GIS is driving growth in cereal by listening to their consumers, results are very positive. Granola variety cereals are up 26%, Cheerios Protein are up 80% and after adding more cinnamon to the CTC sales have risen 12%. One of the most exciting launches is Gluten Free Cheerios, they will start shipping in 1Q16, and we believe that it will be a big hit with consumers.
Where a lot of our confidence in cereal comes from is the stellar performance of cereal within the C&F channel. In nine months of results in FY15 net sales of cereal are up 6% in school, proving people still like cereal and value its nutritional attributes.
The company has big plans for the Haagen-Dazs franchise in emerging markets, added 65 new shops in China and is starting expansion in the AMEA region with a goal to reach 600 shops by 2024.
U.S. yogurt has officially returned to growth, it was a long road here but the team put together growth versus last year in every quarter of FY15. Through listening to the consumer, Yoplait Original is growing at a double digit rate versus last year.
Yoplait is about to launch its yogurt business in China, this is expected to provide a substantial lift in sales in the long run. Yogurt is said to be a $10 billion category in China and Yoplait intends to compete heavily to gain share. There is opportunity to expand yogurt consumption around the world; Brazil is most likely GIS’s next country to target.
This segment has become a huge source of growth in international markets. In Europe, Old El Paso retail dollar sales are up 12% versus last year, in Australia up 9% and Canada up 5%. The Wanchai Ferry team continues to innovate especially on the frozen dim sum line in China which is excelling in the market. Yoki is more than they were hoping for and is extending will into the multiple category in the Brazil market.
SWEET & SAVORY SNACKS
Snacking is a global phenomenon and GIS is poised to take advantage, with strong brands in grain snacks, savory snacks, yogurt, sweet snacks and ice cream. Yoki has a 72.6 value share of the microwave popcorn market in Brazil, and AMEA holds great opportunities for baked snacks. But clearly the leader in snacks for GIS is grain snacks, GIS holds a growing 42.8 dollar share in the category. And they are not getting complacent they continue to innovate and grow with consumer preferences, adding in gluten free options, and bars with simpler ingredient decks.
All-in-all fiscal year 2015 was a year of change and self-reflection for GIS and I believe they are better off for it. But now is not the time to come off the gas pedal, we want management to continue driving the business forward with innovation, strategic acquisitions/divestitures and a cost conscious mindset.
The GIS management team has taken on a lot in FY15, going through a major restructuring and integrating a new business all while innovating on core brands. I am comfortable in saying that they have made improvements to the business, and I for one am excited to see what they have in store for fiscal year 2016. I’m also confident in saying that if management does not get more aggressive with making changes, they might find themselves a target of activists!
As we enter a new fiscal year we expect to see exciting M&A news on both acquisitions and divestitures as well as continued turnaround on the core business. FY16 is a pivotal year, we need to see that the restructuring and cost cutting initiatives have improved profitability and accelerated volume growth of the overall business.
We see GIS as a WIN/WIN situation. If FY16 looks more like FY15, the confidence in management will be shaken and any price decline would cause activists and or potential acquirers to bubble to the surface, which will further lift the stock price. We are holding our bullish stance on the name into their fourth quarter earnings report and expect strong performance/news in the coming quarters.
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Takeaway: Just when we thought AI was taking a break another outbreak was reported.
Editor's Note: Since this note was originally published on May 28, 2015, over one million birds have been euthanized. Our Consumer Staples and Restaurants team is hosting a special "thought leader" call with Dr. Thomas Elam tomorrow Wednesday June 3rd at 11am ET to discuss the effects Avian Flu is having on the food and restaurant industries. Ping email@example.com for access.
The Avian Flu (AI) has been wreaking havoc on the egg and poultry industry this year. As I was researching our previous note on AI on Tuesday (printed on 5/27/15) it was looking that poultry farmers were getting a break with no reported infections for five days. But that optimism was short lived as another outbreak was detected in Nebraska and Iowa, affecting 293,200 chickens and 20,700 turkeys respectively in each state.
Wholesale egg prices continue to rise, nearly doubling versus pre-AI prices. As we previously reported companies are looking elsewhere for eggs, mainly international and alternative egg-substitutes.
Importing eggs is more complicated than it seems, and given the U.S. has always been an efficient producer, few countries are pre-approved for egg importing. French and Dutch farmers are acting fast to try to take advantage of the U.S. AI outbreak, working with their embassy’s in the U.S. to expedite the approval process.
You may be thinking, what is the difference between a U.S. and a European egg? When you travel to Europe you will notice in a majority of supermarkets that the eggs are not refrigerated, while in the U.S. they are always refrigerated. This is because eggs have a natural protectant on them called a cuticle, which acts as a shield to keep bacteria out. In Europe they are required to not clean the eggs and leave the cuticle intact, while in the U.S. all eggs must be washed in 90⁰F water and sprayed with sanitizer. Given this difference there will have to be a change in process to export the eggs to the U.S. but European companies want to take advantage of this opportunity.
After speaking with industry professionals we have determined that the egg prices in Europe are usually priced at about a 20% premium in a non-AI environment, and that to do all the additional cleaning and ship the fresh eggs across the pond would cost an additional 20% on top of that. We have provided our math in the below chart for a visual:
POST provided an update on the recent AI outbreak that is affecting their business. They are now stating that a third of company owned chickens in Nebraska has tested positive for AI. Bringing the total affected supply to ~35% of the company’s volume commitments. Post management has determined that this amount of loss constitutes a force majeure event for the Michael Foods egg business. They have started to take drastic measures to minimize the financial impact such as, discontinuation of certain products and price increases.
HRL has stated that their Jennie-O turkey supply has been greatly impacted by the AI outbreak in Minnesota and Wisconsin and could inhibit their ability to fully meet orders, and will assuredly raise prices. Thanksgiving feels far away but when you calculate the time to clean facilities and get birds to a mature size, it doesn’t seem possible that they will be able to fully rebuild their supply.
As the summer approaches we will begin to see a slow down as the AI and all flu’s for that matter don’t survive well in high temperatures. One concern is when migrating birds from northern states start to fly back south in the fall we may have a relapse of AI, but not to the same extent we are seeing now.
Takeaway: WWW CFO change. PVH Earnings Callouts. FL insider sales picking up. Ashley Furniture shopping itself.
WWW - CFO Don Grimes Departure
Takeaway - This is the second notable change in management at Wolverine in the past month. The first being the departure of Gene McCarthy, who headed up WWW's biggest brand, Merrell, which has been struggling YTD putting up a flat Q1. Let's be clear, however, in that McCarthy leaving was not voluntary, while Grimes' is. Grimes accepted a position to be EVP, COO & CFO of Neiman -- so he's in effect trading up to a $5bn company from a $3bn.
WWW is a deep organization, so there's no doubt in our minds that the company will not miss a beat financially. But where Grimes was particularly strong was in communicating the appropriate message to the investment community. CEO Blake Kreuger is a first-rate CEO and great leader -- but he does not know how to speak to Wall Street. We don’t know the new CFO Michael Stomant -- and while we don't doubt his abilities as CFO given the massive pool of divisional CFOs WWW has to pick from, his 'Wall Street Management' skills are untested.
Nonetheless, we’re comfortable with owning this sleepy name that has several levers. We think that the PLG brands are growing outside the US to a far greater extent than is apparent in the GAAP results. Merrell with the leadership change probably has a free pass for another few quarters. Estimates look extremely achievable this year. Also the Street is not accounting for what should be 500bps in financial deleverage. If we don’t see this, it is likely bc WWW goes ahead and does another deal – and it can stomach up to a $1.3bn transaction at current leverage levels. We usually don’t like deals, but in WWW’s case they usually serve as a positive catalyst.
PVH - 1Q15 Earnings Callouts
1) Excluding translation effects, the growth algorithm in the quarter looked clean. Revenue +3%, EBIT +8%, Earnings +20% with the delta between EBIT and earnings growth driven by an $11mm reduction in interest expense. Net debt to total capital down from 44.4% to 40.9% since 1Q14. The company expects to generate $450mm in FCF this year, and use $350 million of that to pay down debt, with the remainder being used to ‘opportunistically’ fund new $500mm share repo announced today. We wouldn't rule out a deal -- it's what these guys do.
2) On the guidance front, the company took the range up to $6.85 -$6.95 after a $0.12 beat (+9%) from $6.70 - $6.90 while increasing the Fx hit from $1.20 to a $1.25. Relative to expectations, the 2Q guidance looks light (11% below current consensus numbers) as the company benefited, at least on the top line, from the shift of wholesale Heritage shipments into 1Q from 2Q and the shift of the Chinese New Year (which landed in 2Q14) into 1Q15 this year. Fx continues to be a sizable headwind, taking 17 percentage points off the earnings growth for the year. We’ve heard RL take considerable flak for the way it (mis)managed its way through the strengthening dollar, but PVH may be a close 2nd. As a percent of revenue, Int’l is a bigger chunk of PVH’s portfolio at 47% compared to RL at 33%, but 15% earnings dilution is amongst the biggest we’ve seen in this space.
3) We don't currently have a call on PVH. At 14.7x P/E and 10.4x EBITDA, valuation isn’t prohibitive here. Numbers in the near term are coming down, setting a low bar for the quarter PVH will report in 3 months. But, the company will need to continue to keep CK cranking and find a way to turn Tommy. Tommy NA just put up its first negative growth rate (-1% C$) in a quarter in over 4 years, and the first miss usually isn’t the last. Not much margin upside left to engineer, which makes this a very top line dependent story -- and we're uncomfortable making the leap in this situation.
FL - Notable Insider Sale
Takeaway: John Maurer, Treasurer/IR at FL, executed 18,000 options struck at (an average of) $20 worth $775,000. This is the individual that knows the numbers better than anybody. Management stock sales have picked up meaningfully in both size and frequency since former CEO Ken Hicks resigned back in early November. We don't think that's a coincidence.
Ashley Furniture Shopping Itself
Takeaway: We'll be watching this deal with interest. Ashley might be the biggest concept in the home furnishings space that nobody talks about. Fact is, the company is the 2nd biggest concept in the home furnishings space behind only IKEA. At 1x EV/Sales the valuation looks much more like ETH than a higher end concept like WSM or RH. Makes sense that Ashley would be shopping itself in this environment because a) growth looks more or less tapped in the US with a 25k footprint and 475 units and b) productivity is approaching pre-recession peaks up 25% since bottoming out in 2008. But let's be clear...great assets don't need to be 'shopped'.
ICSC - Chain Store Sales
Takeaway: We've seen trends improve marginally since a slow start to the first 1/4 of the year which got his by both weather and the port closure, or so the retailers say. Starting next week, comps get much tougher for the balance of the summer -- when we had a 13-week period of sales growth clocking in at 4% or better (which is VERY high for this data).
DG - 1Q15 Earnings
WMT - Walmart to raise wages for some employees starting in July, promises $10 minimum by 2016
Neiman Marcus Group Names Grimes in Top Role
GME - GameStop Corp. Announces Agreement to Acquire Geeknet, Inc.
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