Image Source: General Mills Inc – Second Quarter Fiscal 2020 Earnings IR Presentation
By Callum Turcan
On December 18, General Mills Inc (GIS) reported second quarter results for its fiscal 2020 (period ended November 24, 2019), which saw shares of GIS rise by almost 2% during normal trading hours that day as investors were excited over its strong performance of its pet food sales. Please note General Mills completed its $8.0 billion all-cash acquisition of Blue Buffalo Pet Products Inc in April 2018, and investors have been eagerly awaiting the revenue growth stimulus that deal was projected to generate. Shares of GIS are trading near the very top of our fair value range estimate and yield 3.7% as of this writing.
We see the company’s dividend payout coverage as weak due to the debt taken on to fund General Mills’ Blue Buffalo purchase. However, we do appreciate management reaffirming full-year fiscal 2020 guidance during General Mills’ latest earnings report, and we also appreciate the company’s ongoing debt reduction efforts. The company has been actively pursuing deleveraging activities and aims to exit fiscal 2020 with a net debt to adjusted EBITDA ratio of 3.5x. While we support these endeavors, please note debt reduction efforts will limit General Mills’ dividend per share growth going forward.
General Mills reported flat year-over-year GAAP revenue growth last quarter, while its GAAP operating profit surged 48% largely due to the removal of substantial one-time expenses. The underlying business, excluding pet segment sales, is largely treading water which is why General Mills’ pet food business is so important.
Analyzing General Mills’ Pet Segment
Net organic sales growth at General Mills’ pet segment rose by 16% year-over-year, largely due to higher volume (added 1300 basis points to that growth rate) and partially due to price/mix (added 300 basis points to that growth rate). Segment operating profit growth clocked in at 14% year-over-year, with higher revenues offset partially by higher media spend. Retail sales growth of its pet product/food offerings came in strong according to management.
Image Shown: General Mills’ pet sales performed quite well last quarter, assisted by rising volumes and favorable price/mix movements. Image Source: General Mills Inc – Second Quarter Fiscal 2020 Earnings IR Presentation
Going forward, General Mills is seeking greater e-commerce sales of its Blue Buffalo brand to support long-term revenue growth. The success of the major pet product e-commerce firm Chewy Inc (CHWY) in terms of pet food sales is a testament to the demand there is out there for a change in the way US consumers (and consumers elsewhere) want to acquire pet food.
Going to the store to buy a large bag of pet food over and over again can often be a huge chore. The “humanization of pets” trend has seen spending on pets in the US rise substantially over the years, making it easier for US households to justify the additional delivery/other costs associated with e-commerce transactions. Management noted that Blue Buffalo’s e-commerce retail sales were up in the high-teens during the first half of fiscal 2020. Here’s what management had to say about General Mills’ pet segment strategy during the firm’s latest quarterly conference call (emphasis added);
“Shifting gears to our pet segment… I am pleased to say that we had a great second quarter with net sales up 16%. Our Q2 growth was driven by strong growth in the Food, Drug and Mass and E-commerce channels, positive price mix and a benefit from the timing of shipments in advance of holiday merchandising. This net sales performance was led by strong double digit growth on Blue’s two largest product lines, Life Protection Formula and Wilderness.
Looking at end-market performance, we drove first half all channel retail sales up low double digits. And we grew share in the pet food category. On the bottom line, second quarter segment operating profit grew 14% versus a year ago, driven by higher net sales, partially offset by higher media expense…
For the full year, we remain well on track to deliver 8% to 10% like-for-like growth in the pet segment excluding the benefit of the calendar differences in fiscal 2020.We remain confident in the long-term opportunities for Blue Buffalo and we’re excited about the growth prospects ahead.”
Looking ahead, General Mills has additional marketing campaigns in the works to support its Blue Buffalo sales growth trajectory. Rising marketing and advertising spend needs to be monitored. That being said, as General Mills is recording strong volume and price/mix growth (implying segment-level gross margin expansion) from its pet segment, it’s worth investing in growing the business further, in our view.
Guidance Reaffirmed
Additionally, management reaffirmed General Mills’ full-year guidance for fiscal 2020 during the firm’s latest earnings report. That guidance includes; 1%-2% net organic sales growth (a non-GAAP figure) on an annual basis, 2%-4% growth in its adjusted operating profit (a non-GAAP figure), non-GAAP adjusted EPS growth of 3%-5%, and most importantly, the company now expects to generate a free cash flow conversion rate of 105% (up from 95% previously).
Image Shown: General Mills’ pet segment will play a key role in unlocking sales and operating profit growth, on an adjusted basis, this fiscal year. Image Source: General Mills Inc – Second Quarter Fiscal 2020 Earnings IR Presentation
Concluding Thoughts
We appreciate General Mills’ strong pet segment performance and think that the business’ outlook is bright. However, General Mills’ other operations are facing serious headwinds including material negative foreign currency movements (the product of a strong US dollar) and limited/non-existent organic sales growth. Further deleveraging efforts are needed, as General Mills exited November 24, 2019 with $13.3 billion in net debt (inclusive of short-term debt). That weighs very negatively on its dividend coverage.
Food Products (Large/Mid-Cap) Industry – ADM BG CPB CAG GIS HSY K KHC MDLZ NSRGY UL UN
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Related: CHWY
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Callum Turcan does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.