This Food Company is Meeting its Challenges
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I’m always fascinated by the dichotomy of interests that occur when companies outline their strategic vision. These days it seems that many investors only really care about next quarter’s EPS numbers, whilst most managements real focus is on the strategic development of the business. A good example of this can be seen with General Mills (NYSE: GIS) recent results. In actuality, there are a number of significant strategic shifts being made in the company but, most commentary has centered on whether the changes would make a few cents differences here or there to EPS in the short term.
In common with many other food companies General Mills is faced with a weak and a price sensitivity core domestic market. Meanwhile margins are being squeezed by rising commodity input costs, Europe is sluggish and emerging markets promise much but remain lower margin profit centers. So what is the company doing about it?
General Mills Outlines a Growth Plan
The solution outlined is to focus on investment in higher growth categories (Yoplait yoghurt, Haagen-Dazs ice cream, snack bars etc) within the US retail market and the continued expansion of its emerging market operations.
In particular, there is a significant amount of investment and new product launches coming for Yoghurt, where Yoplait in the US is seen as lagging in the fast growth Greek yoghurt segment. Indeed yoghurt was a laggard in the US for General Mills, however internationally the category is performing well.
With regards emerging markets, the company is actively looking at launching its yoghurt brands in China and the rollout of 50 Haagen-Dazs stores in China is a sure sign of where the geographic intentions lie. Similarly, the recent acquisition of Brazilian food company Yoki is indicative of a company looking for growth outside its core markets. Indeed, over the last ten years General Mills has gone from being a company with only 5% of its sales being international to over 30% today.
So if the prognosis is a sound strategy of chasing higher growth food categories and emerging market growth, what is happening to its core markets?
Core Markets Weak for General Mills
Conditions have been tough within its core cereal market in the US over the last few years and the response has been to increase media spending whilst trying to pass on cost increases to the consumer. The results of all of this are plain to see. US retail sales made up 63% of sales in 2012 but contributed 76% of operating profits. It is still the core market for General Mills and conditions remain difficult. In fact, US retail sales only increased a net 3.1% with segment operating profit down 2.2%.Costs increased; media spending went up 5% and volumes declined.
In a sense, there is little that the company can do about this. Competitors like Kellogg (NYSE: K) have struggled with pricing as commodity costs soared and shoppers shifted to discounted private label and value brands. In addition Kraft (NASDAQ: KRFT) has decided to deal with the differing prospects within its businesses by separating the faster growing snacks business from its US operations. In particular, Kellogg has had difficulties in retaining market share in the face of rising input prices.
However, General Mills has succeeded in knuckling down and concentrated in the ‘blocking and tackling’ within its operations. There were some impressive reductions in working capital requirement and media spending is forecast to be flattish next year. Media spending had reached very high levels following a few years of strong increases as it defended its brands from market share erosion. Going forward input cost inflation is seen as only 2-3% in 2013, so the company has the opportunity to stop increasing media and promotional spending.
I Love it When a Plan Comes Together
In conclusion, the challenge for 2013 and beyond is to successfully grow the emerging market business whilst trying to retain market share in the core US retail market. Yoplait International, Yoki and Haagen-Dazs and assorted snack bar brands will be the spearhead of the emerging market expansion approach. US operations will focus on consolidating US market share, whilst trying to expand margins following slower growth in input costs and improvements in supply chain efficiencies. In addition, major investments are planned for yoghurt in the US.
General Mills appears to be doing the right things, but these plans will take time to come to full fruition. I note that the International segment only has operating margins at 10.2% versus 21.9% for US retail. In addition, it only made up 14.2% of operating profits.
Management guided towards mid single digit growth in sales with some margin improvements although, operating earnings growth is similarly forecast at mid single digits. The plan to moderate increases in media spending makes sense but it remains to be seen how a competitor like Kellogg might be reacting. In addition, investing in the yoghurt franchise in the US is fine but will not come without execution risk.
The Investment Case?
Dividend investors will love the 3.4% dividend and the solidity of the earnings and the strategic investments make sense. Talk of commodity cost increase moderation and gross margin improvements will encourage confidence further. However as yet, there is little evidence of US consumers shifting away from the ‘new frugality’ approach and unless commodity costs continue to fall, it is hard to see how breakfast cereals will ‘price’ themselves back into being a growth category in the US.
The strategic shifts are fine but they will take time to drop into the bottom line. I suspect there will be plenty of time to see how these initiatives are developing before concluding that General Mills is good value. The stock has been supported over the last year or so as a dividend play in times of uncertainty but, long term investors will be more concerned with the direction of the business.
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