Buy Shares in General Mills, Hold Off on These 2 Peers
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As the Fed begins to intervene in the economy, many investors are eying demand-side momentum. However, the recent stimulus has generally not delivered the results many had either hoped for or expected. Consequentially, non-cyclical consumer good stocks, like food marketers, are an attractive defensive option that gets the best of both worlds: more consumer expenditures from rising incomes and limited downside from recessions. However, this favorable risk/reward has resulted in a dearth of undervalued stocks for the sector. While I find Kraft Foods (NASDAQ: KRFT) and Kellogg (NYSE: K) to both be too expensive, I am interested in buying shares of General Mills (NYSE: GIS).
From a multiples perspective, General Mills is the cheapest of the three. It trades at a respective 16.6x and 13.5x past and forward earnings versus corresponding figures of 15.3x and 14x for Kellogg and 19.8x and 14.5x for Kraft. Over the last 12 months, General Mills has also outperformed with a 10.9% return against Kellogg's -5.5% and General Mills' 3.6%. I recommend buying into this momentum for several reasons.
First, fundamentally, General Mills has showcased impressive operational power. Although the current PE multiple is slightly above the historical 5-year average of 15.7x, free cash flow has gone up dramatically from $882 million in the TTM ending May 31, 2011 to $1.7 billion in the TTM ending May 31, 2012. Although margins have dipped from an average of 10% to around 9.5% during the last three quarters as a result of largely input inflation, cost-cutting has been on the rise.
In addition, not all of the upside has been factored into the stock. During the last three quarters, performance has been generally weak with a 3.8% miss in 4Q11 and a 1.8% miss in 1Q12. Just 7.4% annual EPS growth is forecasted over the next 5 years, despite the fact that EPS grew by 8.2% annually during the past 5 years - a period that included the devastating economic collapse. Since the bar has been set low, General Mills will, in my view, generate high risk-adjusted returns by continuing to beat expectations.
General Mills is also attractive as a defensive play. It has 85% less volatility than the broader market and offers a 3.4% dividend yield. Expansion through acquisitions and joint ventures, for example in Yoplait, have exposed the firm to high-growth markets. This has yet to be appreciated by the market and will help drive value creation in the years ahead.
Kellogg and Kraft, on the other hand, are unlikely to outperform. High expectations have been set for annual growth over the next 5 years at 6.8% for Kellogg (~50 bps more than during the past 5 years). Assuming this is met, the firm will generate 2016 EPS of $4.36. At a 15x multiple, this translates to a future stock value of $65.40. Discounting backwards by 8% yields a present value of $44.51, which is around 8% less than the current market capitalization. This situation is made worse by very high debt at a debt-to-equity ratio of 3.9 and weak liquidity at a quick ratio of 0.43. Accordingly, I recommend holding off from buying already expensive shares.
In terms of attractiveness, Kraft falls somewhere between Kellogg and General Mills. While it is the most expensive stock, it also has the strongest brand name. Analysts currently rate the stock a "buy," and management remains committed to returning free cash flow to shareholders. I am particularly optimistic about how the company is making acquisitions / investments to cross-sell its brand onto new businesses, like biscuit maker Bimo of the National Investment Company. Moreover, the 5% decline in value from last week stemmed from emerging FX headwinds that were overblown.
After the spin-off is completed the beginning of next month, investors will be better able to allocate risk in either an international business or a domestic cash cow business. Much of the value creation has been factored into the stock price, so I recommend, at this point, buying shares after the split. While the international business is positioned for greater growth, it comes with greater risk. In my view, that stock, which will be called "Mondelez International" and trade under the ticker "MDLZ" will outperform the domestic stock Kraft Foods Group (or "KRFT"). For right now, however, the shares are too expensive and do not allow for this risk diversification. Accordingly, I recommend holding out.
The Motley Fool has no positions in the stocks mentioned above. TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
