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General Mills to Gain From Innovations, Rising Costs Hurt

General Mills Inc. GIS has been benefiting from continued strength in its snacks and frozen products, higher net price realizations, and improved mix. However, inflation in commodity prices, and higher freight and logistics costs continue to hurt margins.

Recently, the food giant reported third quarter of fiscal 2018 results, wherein the company’s earnings met the Zacks Consensus Estimate but revenues lagged the same. Meanwhile, the company’s shares have plunged 26.5% in the last three months, comparing unfavorably with the industry’s 12.6% decline.

Earnings estimates for the current quarter and year have moved south by 4.7% and 1.3%, respectively, in the last seven days. The company’s weak sales growth trajectory and margin woes may impact the stock’s performance in the upcoming quarters.


A Look at the Company’s Sales Performance and Outlook

General Mills, like many other U.S. food producers, has been struggling due to the shift in consumer preferences toward natural and organic food. Management is trying to turn around the U.S. Retail business through consumer-focused innovation and marketing.

After sales declined 3.5% in the fiscal first quarter, General Mills’ sales showed marked improvement in the fiscal second quarter. Total revenues of $4.2 billion grew 2.1% year over year, owing to higher sales across the board.

General Mills also continued its sales growth momentum in fiscal third quarter. The company’s sales of $3.9 billion improved 2.3% from the prior-year quarter owing to higher sales across the board. Higher net price realizations and improved mix helped General Mills report improved sales performance. Favorable currency translation rates also supported its top line.

The company’s legacy North America Retail segment’s revenues grew 1% to $2.52 billion due to 6% growth in the Canada operating unit, 3% in U.S. Snacks, and 2% in U.S. Meals & Baking business units. Continued strength in its snacks and frozen products has helped the company post better numbers. Moreover, the Soup and Baking segments also positively impacted the company’s sales.

The company’s focus on consumer-focused innovation seems to be bearing fruits. New products like Chocolate Peanut Butter Cheerios, Oui by Yoplait, and Yoplait Mix-Ins have been generating solid demand. Nature Valley snack bars have also witnessed higher demand.

That said, yogurt and cereals continue to remain a drag on its top line. Net sales were down 8% in the U.S. Yogurt and 1% in U.S. Cereal in the recently reported quarter. In the first nine months of fiscal 2018, U.S. Cereal net sales were down 1% and sales in the U.S. Cereal unit were down 14% from the year-ago level. While management is taking initiatives to reinvigorate this priority business through innovation and increased promotional support for new products, we are yet to see significant growth.

For fiscal 2018, General Mills reiterated its sales guidance and expects its organic sales to remain flat. The company’s sales are expected to benefit from its new products as well as from its acquisition of Blue Buffalo Pet Products. However, sales weakness in cereals and yogurt remain a headwind.

Higher Costs to Compress Margins

General Mills continues to disappoint on the margins front. Gross margin and operating margin contracted 250 basis points (bps) and 120 bps, respectively, in the fiscal third quarter. The downside was due to higher input, freight and manufacturing costs.

A tepid sales environment, higher spending to support top-line growth and price competition among retailers are expected to hurt margins of the packaged food manufacturers like General Mills, Kellogg K, Kraft Heinz KHC, Hershey HSY, and others.

General Mills expects inflation in commodity, transportation and other operational costs to adversely impact its fiscal 2018 margins. Hence, the company cut its operating profit and earnings guidance for the fiscal year. General Mills expects its operating profit to register a decline of 5-6% in fiscal 2018. Earlier, it had expected its operating profit to either decline 1% or remain flat.

Also, the company, with a Zacks Rank #3 (Hold), has slashed its expectation for adjusted earnings per share (constant currency) growth from flat to up 1% versus prior expectation of 1-2% growth. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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