General Mills raised bottom-line and free cash flow conversion expectations for fiscal 2019, but we’re not interested in shares as it continues to prioritize deleveraging over dividend growth in a slow growth environment. International corporations continue to weigh the impact of slowing macroeconomic activity and global trade tensions, as evidenced by FedEx and BMW slashing bottom-line expectations, and shares of Biogen have been rocked by news that it terminated two late-stage studies of a key Alzheimer’s treatment.
By Kris Rosemann
General Mills Turns in Positive Organic Sales Growth and Operating Margin Expansion
Food products giant General Mills (GIS) turned in better-than-expected results in its fiscal 2019 third quarter report, released March 20, as organic sales growth advanced 1% on a year-over-year basis and adjusted operating profit margin expanded 230 basis points from the year-ago period. Positive net price realization and mix more than offset lower volume in the quarter, and cost savings and benefits from positive price and mix were more than enough to offset higher input costs. Adjusted diluted earnings per share advanced 6% from the comparable period of fiscal 2018 to $0.83.
Positive organic sales growth has not been easy to come by for General Mills, which was a key driver in its decision to purchase pet food producer Blue Buffalo, and management continues to expect organic sales growth to finish fiscal 2019 at the lower end of its initial guidance range of flat to up 1%. However, the company raised its constant-currency adjusted diluted earnings per share guidance to flat to up 1% from fiscal 2018 from flat to down 3% previously, and free cash flow conversion of adjusted after-tax earnings guidance was raised to 105%+ from previous guidance of 95%+. Through the first three quarters of fiscal 2019, it generated nearly $1.7 billion in free cash flow, down roughly 4% from the year-ago period.
Expectations for higher free cash flow generation bodes well for General Mills’ near-term focus on deleveraging following its purchase of Blue Buffalo. The company has put share repurchases and dividend growth plans on hold at least through the end of fiscal 2020 as it works to hit a net debt-to-adjusted EBITDA ratio of 3.5x by the end of fiscal 2020 (the measure was 4.2x at the end of fiscal 2018). As of the end of the third quarter of fiscal 2019, management has reduced its net debt load to less than $14.5 billion from more than $15.4 billion at the start of the fiscal year.
Shares of General Mills are currently trading in the upper half of our fair value range, and we remain uninterested in adding exposure to the company as it continues to search for organic growth. Blue Buffalo may very well be able to deliver in this regard as the $30 billion US pet food market advanced at a ~5% CAGR from 2007-2017, and the humanization of pets continues to drive premiumization within the category. Nevertheless, management’s decision to focus on deleveraging following the deal, which we see as prudent, at the expense of returning capital to shareholders, which is a key staple for investors in the mature consumer packaged goods market, speaks to the challenges facing the group.
Macroeconomic Uncertainty and Global Trade Tensions Impacting Bottom-Line Expectations for FedEx and BMW
In its fiscal 2019 third quarter earnings report, released March 19, FedEx (FDX) lowered its fiscal 2019 (ends May 2019) earnings guidance for the second consecutive quarter, and it has now changed its bottom-line expectations for the fiscal year in each of its past four earnings report, dating back to its fiscal 2018 fourth quarter report. Slowing macroeconomic conditions and weakened global trade growth are weighing on its international revenue performance, and softness in international volumes weighed on operating margin performance in its fiscal third quarter. Management is constraining hiring, limiting discretionary spending, and reviewing other actions to more closely align costs with the lower than previously expected revenue trends.
FedEx now expects adjusted earnings per diluted share to be in a range of $11.95-$13.10, down from its prior guidance of $12.65-$13.40, which was significantly lower than the guidance range of $15.65-$16.25 per share issued in its fiscal 2018 fourth quarter report. Shares of FedEx are currently changing hands in the lower half of our fair value range, but we’re not interested in adding exposure as management continues to work to gain a better handle on the business amid the heightened level of uncertainty facing global macroeconomic activity and global trade levels.
German automaker BMW (BMWYY) released a disappointing outlook for its 2019 bottom-line performance and expects a “significant decrease” in pre-tax profits in the year due to intense competition in international auto markets, uncertainty surrounding political and economic developments in Europe (primarily due to Brexit-related uncertainty), and trade tension between the US and Europe and the US and China. Volatile currency exchange rates and raw material costs are also expected to weigh on bottom-line performance in the year. The company does not expect a reversal of the relatively weakened international auto market performance seen in 2018, and the group continues to weigh the potential for a more meaningful slowing of international economic activity. General Motors (GM) remains our favorite idea in the auto space and is included in both the simulated Best Ideas Newsletter and Dividend Growth Newsletter portfolios.
Biogen’s Shortcoming in Alzheimer’s Treatment Highlights Inherent Risk in Biotech
Shares of Biogen (BIIB) cratered early in the trading session March 21 after the company announced the termination of two Phase 3 trials for aducanumab, a treatment for patients with mild cognitive impairment due to Alzheimer’s and mile Alzheimer’s dementia. An independent data monitoring committee determined the trials were unlikely to meet their primary endpoint with respect to the efficacy of the treatment. Data from the studies will be used to inform ongoing research, but a related Phase 2 safety study and a long-term extension study, currently in Phase 1b, will be discontinued as well.
As evidenced by the sharp decline in Biogen’s share price, aducanumab carried lofty expectations, and it was granted Fast Track designation by the FDA in September 2016. The treatment’s failure at such a late point in the development cycle highlights the inherent risk present in the drug development process, which is extremely complex and difficult, even for a potential treatment that has been granted Fast Track designation from the FDA.
Aducanumab was a key part of Biogen’s pipeline in its core growth area of Alzheimer’s and was one of four treatments in Phase 3 trial as of the end of 2018. How its failings will impact other of Biogen’s Alzheimer’s treatments, such as Phase 2 pipeline candidate BAN2401, which shares a number of features with aducanumab, remains to be seen, but the shortcoming may very well make its presence known, as management indicated it expected to begin meaningful investments in launch preparation activities for the treatment in 2019.
We’ve lowered our fair value estimate for shares of Biogen to $277 each after adjusting near-term expectations.
Food Products (Large/Mid-Cap): ADM, BG, CPB, CAG, GIS, HSY, K, KHC, MDLZ, NSRGY, UL, UN
Air Freight & Logistics: CHRW, EXPD, FDX, FWRD, HTLD, JBHT, KNX, ODFL, HUBG, UPS, WERN
Auto Manufacturers: F, GM, HMC, HOG, TM, TSLA
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Kris Rosemann 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.