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.
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.
Please call or e-mail with any questions.
Howard Penney
Managing Director
Shayne Laidlaw
Analyst