EUR 850.00 For Business Accounts Only

Morningstar | General Mills Ends Year With Enhanced Profitability Despite Slightly Lukewarm Organic Sales

While wide-moat General Mills largely ended the year in line with our expectations, we suspect concerns around the firm's organic growth prospects remain an overhang on shares. Fiscal 2019 sales growth fell slightly short of our expectations (with sales up 7.2%, versus our estimate of nearly 8%), with organic sales remaining flat (including a 1% decline in the fourth quarter) versus our expectations for slightly below 1% growth. However, we were pleased to see profitability strengthen, with full-year adjusted operating margin expanding 30 basis points to 16.9% (comparable with our outlook) thanks to the firm's cost savings initiatives and addition of Blue Buffalo into its mix. These factors led to full-year adjusted EPS of $3.22, which compares favorably with our $3.14 estimate.

While we expect sales growth to be constrained to a low-single-digit clip longer term, we surmise the firm's efforts to revitalize its brand set will bolster its top-line trajectory and were encouraged by its success in stabilizing distribution and pricing in the U.S. (with organic price/mix in the North America retail segment up 1% in fiscal 2019 versus a 1% decline the year prior) over the course of the year. We intend to reassess our assumptions in light of these results and management's fiscal 2020 outlook but don't expect a material change to our $57 fair value estimate. With shares declining by a mid-single-digit percentage on the announcement, we think the name provides an attractive entry point for patient investors.

Performance in the North America Retail segment (59% of sales) aligned with our expectation for a 1% decline in full-year organic sales. However, a 2% decline in organic sales in the fourth quarter suggests that a linear path to recovery is far from likely.

From a category perspective, an improving trajectory for U.S. cereal and yogurt (both of which posted flat sales in the fourth quarter) was offset by erosion the U.S. snacks business (which contributes roughly one fifth of consolidated sales), which declined 5% during the quarter. We surmise the firm will rely on the same strategic playbook it has used to refresh businesses like U.S. yogurt (where General Mills' share of retail sales increased by 10 basis points over the year prior thanks to improved execution across its core portfolio and newer offerings with more simple/nutritious ingredients) to bring value-added innovation to its U.S. snacks business. Further, we note this underperformance doesn't seem to transcend geographies. For example, retail sales for U.S. snack bars declined by a mid-single-digit percentage, but bars were one of the strongest contributors to international growth (30% lift in retail sales).

Moreover, the Pet segment (8% of sales) provides another attractive avenue for top-line growth, with pro-forma annual sales growing 11% (or high-single-digits with an adjustment for shipping days). Blue Buffalo's distribution continues to expand within the food, drug, and mass (FDM) channels, including the expansion of BLUE to Walmart in the fourth quarter, and management estimated that ACV (a metric of distribution) in these channels reached 65% at the end of the fiscal year. Fourth-quarter retail sales for FDM customers with Blue products for more than 12 months were up 29% over the year, which suggests significant runway for growth within this channel over the years ahead. Similarly, Blue Buffalo products gained market share and posted 21% retail sales growth in the e-commerce channel (which accounts for roughly a quarter of pet segment sales). We appreciate that this channel diversification mitigates General Mills' exposure to the declining pet specialty channel (where the firm's retail sales fell by a double-digit level), as pet owners increasingly look for fare in FDM and e-commerce channels.