EUR 850.00 For Business Accounts Only

Morningstar | General Mills' 3Q Results Reflect Ability to Balance Brand Investments With Bottom-Line Expansion

Wide-moat General Mills posted strong third-quarter results, with strengthened price/mix (up 3% on an organic basis, accelerating from 2% in the first half) and profitability expansion prompting management to raise its full-year outlook for adjusted EPS growth (to a range of flat to up 1%, from a range of flat to down 3% prior and versus our negative 1% estimate). From our vantage point, the firm's sustained investments behind its brands (with combined spending on advertising and research and development averaging nearly 6% of sales over the past five years) have enabled it to revitalize its top line and strengthen margins despite competitive pressures and ongoing input cost inflation. In this context, we were pleased to see adjusted operating margin expand 230 basis points to 17.4%--despite these headwinds--thanks to positive price/mix effects, cost savings, and contributions from Blue Buffalo (with Pet segment operating margin standing around 21% this quarter).

Year to date, flat organic sales performance and adjusted operating margin of 16.8% (60 basis points above the prior year period) are comparable with our full-year expectations of negative 0.4% and 16.7%, respectively. We aren't anticipating a substantial change to our $57 fair value estimate as we incorporate these results and are holding the line on our longer-term outlook, which calls for around 1% organic sales growth (driven by price/mix) and north of 17% operating margin on average over the next five years. We continue to view shares as attractive, even in light of a modest uptick on the announcement.

In the North America Retail segment (60% of sales), organic/mix held steady at 2% while volume trends improved (declining 2%, versus a 4% decline in the first half). While we expect the segment to post a 1% decline in full-year revenue, we posit the segment can return to growth (driven by price/mix) by fiscal 2021 as General Mills brings value-added innovation to market and strengthens execution behind its core brands. In this context, we view improving U.S. retail sales trends (with the two-year average returning to a positive level) as a sign of positive momentum in the firm's domestic portfolio. Further, segment operating margin expanded 250 basis points to 23.1% thanks to this positive pricing environment and better leveraged overhead costs.

From a category perspective, the U.S. cereal business grew 4% (versus a 1% decline in the first half), supported by market share gains (management estimates its value share stands around 32.5%, or 90 basis points above fiscal 2018) and price/pack management. However, U.S. Yogurt continued to falter, with sales declining 2%, which is comparable with the low-single-digit levels seen in the prior two quarters. Although General Mills' share performance in this category has improved as of late (remaining flat year to date, versus low-single-digit annual declines between fiscal 2016 and 2018), it remains weighed down by underperformance in its Greek and light yogurt offerings. Year to date retail sales in the Greek and light yogurt categories fell 36%, largely due to the firm's efforts to rationalize its distribution and adjust its product assortment to better align with consumer tastes.

While we're not blind to the headwinds the firm has faced in this business, largely due to its slow response to the Greek yogurt trend, we continue to appreciate management's focus on refreshing its core brands and exploring faster-growing subsegments in which it can be an early mover. In this context, it has achieved a 1% increase in year-to-date retail sales for Yoplait Original and Go-Gurt (which represent over half of its U.S. yogurt portfolio) and a 74% increase for "simply better" yogurt brands like Oui by Yoplait and YQ (above 10% of its category sales, by our estimates). In our view, these offerings are evidence of the firm's ability to adapt its offerings (even under its most established, core brands) to better align with consumers' preference for healthier, more natural fare.

Performance in the Pet segment (8% of sales) was also robust, increasing by 4% on a pro forma basis (and lapping a 15% increase in the prior year period) as growth in the food, drug, and mass (FDM) and e-commerce channels was partly offset by declines in the pet specialty channel. Management expects north of 30% pro forma sales growth in the fourth quarter, as it expands distribution in the FDM channel (with ACV expected to reach 65% in April, or roughly double its October level) and launches a new brand (Wilderness) in this channel. We expect momentum in the Pet business to continue over the next several years (forecasting a high-single-digit percentage increase in sales over this time frame) as Blue Buffalo's fare continues to gain shelf space, maintains its leading presence in the faster-growing e-commerce channel (which already contributes around 25% of its sales), and benefits from humanization and premiumization trends in the pet food market.