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GIS | SEEING THE LIGHT AT THE END OF THE TUNNEL

General Mills (GIS) is on our Hedgeye Consumer Staples Best Ideas list as a LONG.

 

Our fundamental turnaround thesis has continued to play out on General Mills since we went LONG in May 2015.  To view our original Black Book presentation we presented, please CLICK HERE. There were two ways to get paid by going long GIS.  First, an activist could push the company to take a more holistic view of profitability and/or the fundamentals improve to create shareholder value.  The performance in 1Q16 suggests that the latter has taken center stage.  We are growing even more confident in the current management teams plan and think that they are on the right track. We do still however hope to see a natural & organic acquisition that adds to their growing portfolio.

 

1Q16 RESULTS

Constant-currency comparable net sales increased by 2% in 1Q16, while comparable volume was up 1%. General Mills reported total company net sales in 1Q16 of $4.21B coming in slightly under consensus estimates of $4.25B. Embedded within the overall company top line miss is a top line beat within the U.S. Retail segment, which reported sales of $2.53B versus consensus estimates of $2.51B. We will dig into the details further below, but performance in the U.S. has consistently been a source of concern for investors and management, the fact that the U.S. segment has outperformed expectations is a big deal. Adjusted gross margin increased 290 basis points due to net price realization and cost cutting initiatives. Due to Project Catalyst, their corporate cost cutting program, SG&A declined 6%. Cost cutting initiatives have been serving GIS well, reporting EPS of $0.79 ex-items beating consensus estimates of $0.69 by $0.10.

 

U.S. RETAIL― 1Q16 net sales for the U.S. Retail segment (USRO) rose 4% to $2.53B, Annie’s contributed 3 points of the net sales growth. The most encouraging performance in this segment is the growth of cereal, facing an easy comparison of -9%, cereal was up 6% in this quarter. Facing easy comparisons for the next two quarters, coupled with improvements to the segment, we are expecting the positive numbers to continue. The segment experienced a segment operating profit increase of 38% due to lower promotional spending versus a year-ago and a decrease in SG&A expenses and supply chain costs related to Project Catalyst and Century.

 

INTERNATIONAL― 1Q16 net sales for the International segment increased 5% in constant currency. Overall pound volume growth for the segment rose 4%. Top line growth was led by Europe which was up 7%, Canada up 5%, Asia/Pacific up 3% and lastly, Latin America up 3%. GIS continues to see challenging operating environments in China and Brazil. While good growth is occurring in Europe, Argentina and Mexico. Notable growth across the segment: Grain snacks retail sales in Canada grew 18%, led by Nature Valley and Fibre 1 and Häagen-Dazs retail sales in Europe grew 22%. Yoplait China is off to a strong start, after roughly three months in the Shanghai market they have reached a 5% share. The team is methodically growing the business, learning from the consumer, before expanding distribution.

 

CONVENIENCE & FOODSERVICE― A segment that has been growing at MSD for the last three quarters has returned to the LSD range, with net sales increasing just 1% to $478mm. We are not worried about this slowdown as the business has been divesting low margin business consistently over the last few years, and building out their branded business. We continue to like this business for GIS, and the foodservice segment is appealing, especially as they introduce their natural and organic brands and piggy back off the marketing work that the USRO segment does.

 

WHAT WE LIKED

CEREAL

We have been the cereal market bulls since our Black Book presentation on GIS. Our view has always been that cereal is not in a secular decline, it is merely at a point of maturity. Manufacturers had previously been complacent with the cereal market for too long, innovation deteriorated and sales followed suit. Since this realization the three big players in the market (GIS, K, & POST) have been investing in the category both on advertising and product improvements. General Mills is starting to see an uptick in their performance, and we predict they will be the biggest beneficiary of a stronger category.  In the first chart below, the black line shows the YOY monthly change in Breakfast Cereal Employment, graphed alongside GIS cereal reported net sales YOY quarterly growth and cereal category retail sales provided by Nielsen. This bodes well for the future of cereal, as employment in this sector has been picking up steadily. The second chart is data collected by Packaged Facts, showing usage rates of breakfast cereal as well as the importance of breakfast. Strong employment numbers coupled with innovation such as gluten-free Cheerios, removal of artificial colors and flavors and sugar reduction; lead us to continue to believe the cereal category can return to growth.

GIS | SEEING THE LIGHT AT THE END OF THE TUNNEL - chart 1 a

GIS | SEEING THE LIGHT AT THE END OF THE TUNNEL - CHART 2

 

INNOVATION & RENOVATION

General Mills is revamping major brands and adding new products, the biggest one being gluten-free Cheerios. In its early days (3 weeks) management spoke of strong trends and increased adoption especially on Honey Nut Cheerios as it was the first to ship. At the beginning of the fiscal year, in June, Nature Valley launched granola bites and muesli to strong fan fair. Coming off of that strong launch they will be adding clusters and bites to their portfolio in the 2H. Yoplait is continuing to grow their Greek business with Yoplait Plenti, a heartier yogurt with grains and removing 25% of the sugar in Yoplait Original. Annie’s is adding kid’s organic yogurt and a new soup line packaged in Tetra Pak to appeal to the natural & organic focused consumer. The list goes on, bottom line this is one of the better lineups we have seen that is focused on everything the consumer wants.

 

E-COMMERCE

E-commerce has a growing presence in food, whether it is getting your meals delivered or just groceries. It is a small part of the GIS business right now, but they are placing big bets in the U.K. and France where shoppers are buying full baskets online and in the U.S. where there is more of a spearfishing approach, where a consumer buys a single product. In the U.S., General Mills has established an e-commerce center of excellence, a team of 10-15 people located at HQ focused on making sure GIS takes full advantage of this segment.

 

STILL WAITING FOR SKU RATIONALIZATION

A question was asked that we have been harping on as well; why not rationalize lower performing SKU’s in order to fully focus the business on the top 450 SKU’s self-identified by management? Green Giant is an example of rationalizing the portfolio, and we liked that (click HERE for our deal overview) but we are thinking more along the lines of underperforming SKU’s, not entire businesses. We understand the rationale that they soak up overhead and such so you can’t just go around discontinuing items. We feel that there are still some that can go without too much fuss, but we are not the decision maker here and will have to leave it up to management to make the right decision.

 

MANAGEMENT OUTLOOK

Management left guidance unchanged with flat net sales, segment operating profit up LSD and adjusted diluted EPS up MSD. We feel that management is leaving some in their back pocket to protect against any unforeseen downside. The last thing they want is to have another year of underperformance and have to guide down, again. This is fine with us, we will wait for another quarter or two as we anticipate all of their work will reap positive benefits.



HEDGEYE OPINION

We are LONG General Mills for the TREND/TAIL durations. We believe this company continues to be one of the best investments in the consumer staples space. There are many that believe management is sleepy and not acting in the best interest of the shareholders.  Fiscal 2016 could be the year that analysts and investors will shed the notion that they are stuck in the past and unwilling to change their ways. This is evident by the major divestiture of Green Giant and the robust cost cutting programs implemented in an effort to right size the company and propel growth. GIS is built of a portfolio of strong brands that are bringing innovation to their respective categories. Alongside growth and price appreciation, GIS sports a 3% dividend yield, which increases consistently. In the words of General Mills’ CFO, Don Mulligan, “it’s only one quarter,” nonetheless we have faith in the plan and feel that the year will play out favorably for General Mills.

 

GIS | SEEING THE LIGHT AT THE END OF THE TUNNEL - CHART 3

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 


Cartoon of the Day: Surrender Flag?

Cartoon of the Day: Surrender Flag? - Market signaling cartoon

"It's not making mistakes in markets that kills you," Hedgeye CEO Keith McCullough wrote earlier today. "It's staying with them. Be very careful right now."


McCullough: Be Very Careful Right Now

The catalyst for European equities? Simple. More cowbell. Not growth—cowbell

 

You need to be very careful right now. A lot of the things that have been working for us (and could continue working like oil and gold) could go down considerably if Mario Draghi devalues the Euro tomorrow. The U.S. Dollar would go straight up on that.

 

As our European analyst Matt Hedrick pointed out in this morning’s Early Look:

 

…We continue to point out that European equities have been bombed out (the German DAX is down over -20% since April = crash), in-line with our 3Q15 Macro Theme of #EuropeSlowing.  At the meeting, we wouldn’t be surprised to see Draghi 1) talk down the euro (in the near past, European equity markets have acted favorably to a weak EUR/USD – Germany in particular with 46.5% of the economy levered to exports – and 2) suggest more QE may be in the pipe (an increase in monthly purchases above the original target of €60B/month).

 

The volatility that is trending higher is most likely here to stay. Take a look around the world. Right now you have the Chinese, Japanese, Europe and the United States all in a mad race to the bottom. (Case in point: Check out what happened in Brazil on Friday.)

 

Make no mistake: This currency crisis is the epicenter of the central planning crisis.

 

McCullough: Be Very Careful Right Now - currency wars

 

600 some odd rate cuts… a failure to create the economic growth which they promised, etc, etc. It’s just going to be a continuing series of one panic after another.

 

That’s why we’re recommending you keep a lot of cash on hand. Tactically, when the opportunity presents itself, you’re going to be able to take that cash and buy stuff when it’s oversold. And short that stuff when it’s overbought.

 

This is how I am operating in the midst of this global mess.

 

My team here has been doing a damn good job navigating our subscribers through all of this I might add. And I’m not going to apologize for it.


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Should You Stay Away From U.S. Equities?

 

In this excerpt from today's edition of The Macro Show, Hedgeye CEO Keith McCullough responds to a subscriber’s question wondering whether they should steer clear of the U.S. stock market.

 

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Retail Callouts (9/22): TIF, De Beers, Retail Sales Trends

Takeaway: 1) De Beers 2 Negative Comments On Diamond Demand in Past Month - Staying short TIF. 2) Weekly Retail Sales still trending South.

TIF - De Beers 2 Negative Comments On Diamond Demand in Past Month

De Beers has made two moves over the past month that are extremely bearish for the diamond market and diamond demand more generally.  First the company announced that it would be cutting rough diamond prices by up to 9% in the face of weak demand. And just yesterday De Beers committed to pumping marketing dollars into China to attract gift givers in the 18-29 demo and pump up its penetration in 3rd and 4th tier cities. The largest diamond producer in the world cutting prices and spending up to attract consumers in 3rd/4th tier cities is hardly comforting.

For TIF --  Asia Pacific as a whole makes up 25% of TIF's revenue, China holds ~10% of the company's global store base, and its exposure to the PRC consumer is even higher when you factor in tourism spend. Yes, TIF is at a higher end of the scale than De Beers, but when a company with 50% market share of the total sales volume shows cracks, it’s tough to argue that it won’t reverberate through the entire industry. Especially when you consider the fact that diamond jewelry as a % sales at TIF is at all-time highs.

We went negative on TIF a month ago and while numbers for next year have come down by 5% from $4.78 to $4.55 since the last print, we still think this a good short. The reality with this company is that there are no obvious margin levers to offset the declining growth profile in the business, especially amidst increased late cycle risks. We’re staying short this one.

(http://www.bloomberg.com/news/articles/2015-09-22/de-beers-pushes-gift-giving-to-arrest-china-s-diamonds-slowdown)

Retail Callouts (9/22): TIF, De Beers, Retail Sales Trends - 9 22 chart1

 

The downward trend in the ICSC and Redbook sales indexes shows no sign of abating.

Retail Callouts (9/22): TIF, De Beers, Retail Sales Trends - 9 22 chart2

Retail Callouts (9/22): TIF, De Beers, Retail Sales Trends - 9 22 chart3

 

SPLS, ODP - NY Post reporting that the Staples - Office Depot merger may be stopped the FTC's Deborah Feinstein.  The Post also ran an article cautioning FTC approval on the deal back in June.

(http://nypost.com/2015/09/21/staples-office-depot-11-3b-merger-may-not-happen-ftc/)

(http://nypost.com/2015/06/24/staples-merger-unlikely-after-judge-blocks-syscous-foods-union/)

 

NKE - Nike unveiled an expanded eyewear collection in collaboration with Kevin Durant.  Glasses start at $200 for adults and $140 for kids.

(http://footwearnews.com/2015/influencers/athletic-outdoor/kevin-durant-eyewear-kd8-nike-152958/)

 

OLLI - Ollie's Names Robert N. Fisch, CEO of rue21, to board of directors, expanding the board from 6 to 7.

(http://investors.ollies.us/phoenix.zhtml?c=254045&p=irol-newsArticle&ID=2089069)

 

SHLD, AMZN - Sears hires new president of fulfillment Girish Lakshman, who has 15 years of experience with Amazon.

(http://searsholdings.mediaroom.com/index.php?s=16310&item=137389)

 

SPWH - Sportsman's Warehouse making 6.25mm share offering, value of ~$88mm as of yesterday's close.

(http://www.sec.gov/Archives/edgar/data/1132105/000119312515324432/d54747d424b5.htm)

 

GCO - Genesco Board authorized a $100mm in stock repurchase, replacing ~$15mm remaining on prior $75mm 2013 authorization.

(http://phx.corporate-ir.net/mobile.view?c=75042&v=203&d=1&id=2089257)

 

PLCE - The Children's Place is amending its current credit agreement to extend the term until September 2020 and increase the revolving credit limit from $200 million to $250 million. (http://www.sec.gov/Archives/edgar/data/1041859/000114420415055829/v420679_8k.htm)


The Macro Show Replay | September 22, 2015

 


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