EUR 850.00 For Business Accounts Only

Morningstar | General Mills' North America Retail Segment Continues to Stabilize in 1Q; Shares Inexpensive

We still see opportunity in shares of wide-moat General Mills following largely solid first-quarter results, including 9% sales growth (in line with our 9%-10% expectation for the year and including Blue Buffalo), with two-thirds of these gains driven by volume. While adjusted gross margin contracted 160 basis points to below 34%, this was largely due to a one-time purchase accounting charge related to the Blue Buffalo acquisition (130 basis point impact to gross margin), as well as industrywide input cost inflation, which management expects to amount to 5% of cost of goods sold this year (1% above the year prior). We expect strengthening price/mix (incorporating a low-single-digit increase into our full-year outlook) and further benefits from the firm's cost-savings initiatives will help mitigate these headwinds as the year progresses, and we are maintaining our annual expectation for gross margin of 34%-35%. While we posit that General Mills' road to recovery may be rocky over the near term, as it continues to integrate Blue Buffalo and weather-elevated input costs, we're holding steady on our longer-term outlook, which calls for low-single-digit sales growth and average operating margin in the high teens. Consequently, we aren't anticipating a significant change to our $59 fair value estimate.

Performance in the North America retail segment (roughly 60% of sales) continues to recover, with management citing share gains in eight of the firm's nine categories, thanks to efforts to revitalize its portfolio and develop offerings that better resonate with consumer preferences. In this context, we were pleased to see further improvement in the cereal and yogurt categories, which contribute nearly a third of sales in aggregate. U.S. cereal sales increased around 1% (gaining 10 basis points of market share, according to management), due to healthy results for core brands like Trix (60% retail sales growth) and Lucky Charms (9% retail sales growth).

We're also encouraged by sequential improvement in the yogurt business, which has averaged low-single-digit declines over the last five years, but posted flat retail sales and gained 50 basis points of dollar share (albeit after losing around 5% share over the prior two years), according to management, during the quarter. However, we appreciate strengthening innovation in this category, as evidenced by products like Oui by Yoplait (which continues to gain distribution) and YQ, a higher-protein yogurt made with ultrafiltered milk. We expect sales for the overall North America retail segment to return to growth by fiscal 2020, as General Mills' efforts to reshape its portfolio continue to take hold, but our outlook for volume growth remains quite muted at just 1%, given the lukewarm prospects for categories in the center of the store.

However, we contend that General Mills' international and pet businesses have more substantial top-line potential. In this context, organic sales grew 8% (including 5% volume growth) in the Asia and Latin America segment (nearly 10% of sales), as the firm continues to strengthen its distribution and regional offerings in developing markets. Further, retail sales in the pet segment (8% of sales) were robust, up 9%, as we posit that General Mills was able to leverage its entrenched retail relationships to further grow distribution of Blue Buffalo's fare into food, drug, and mass channels, or FDM, (Blue Buffalo had started to expand its reach into these channels last year, but penetration stands at just 30%). We view this as prudent, as consumers continue to shift from the pet specialty channel (where Blue Buffalo has historically maintained a foothold), in which total retail sales declined by a mid-single-digit percentage in the first quarter, to the FDM and e-commerce (where Blue Buffalo posted 36% retail sales growth in the first quarter) channels.