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Consumer Staples: One Buy, One Sell

You should feel good about owning General Mills, but think twice about Mead Johnson

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Kellogg’s (K) second-quarter results Thursday morning were a bit of a mixed bag. On one hand, it seems its U.S. business isn’t performing up to expectations forcing it to cut 2013 revenue estimates. On the other hand, it reaffirmed its full-year earnings guidance.

Clearly its future, while generally positive, is still a bit murky.

Also murky is the S&P 500’s consumer staples sector. It’s up 18% year-to-date — nearly identical to the index in its entirety, making it very difficult to predict where packaged goods stocks like Kellogg are headed.

Nonetheless, I’m going to recommend a couple of plays: specifically, buying General Mills (GIS) and selling Mead Johnson Nutrition (MJN). Read on and I’ll explain why:

Organic Growth

During the past two years, General Mills grew its international revenues by 79% to $5.2 billion, largely on the back of two acquisitions. However, during its annual meeting on Tuesday, CFO Dan Mulligan said the company has no M&A plans in 2014, and instead will work on growing organically through the introduction of more than 200 new products. Besides, with the integration of both Yoki Alimentos and Yoplait still ongoing, it doesn’t need any more distractions.

Never say never, but the company appears sincere.

Brands getting busy in 2013 include Betty Crocker, Cheerios, Chex, Progresso, Hamburger Helper and Yoplait. You cannot continue to grow if you’re not introducing new products. Acquisitions might add to the variety of brands you’re able to offer grocery stores, but you need to keep up with consumer trends if you want to stay relevant.

General Mills almost missed the boat when it comes to Greek-style yogurt. Originally delivering a cheaper product that didn’t resonate with consumers, Yoplait’s U.S. yogurt market share dropped from 40% in 2010 to under 30% at the beginning of 2013. GIS went back to the drawing board, coming up with Greek 100. The 100-calorie offering has earned a Weight Watchers International (WTW) endorsement, and it has been so successful it will generate $140 million in its first year of sales. Most new product launches are lucky to do $50 million in first-year sales.

Meanwhile, GIS stock is up 30% year-to-date — easily its best performance in the past decade. That’s not bad, considering General Mills is a remarkably consistent stock with just one losing year in the past 11 — and even then it was only a 1% decline.

I don’t expect you to buy GIS stock just because it’s consistent, but that certainly helps.

No, I think you should buy General Mills because of its financial strength compared to its peers. Levered free cash flow — which subtracts interest and principal payments — as a percentage of enterprise value gives us a pretty good idea whether its stock is cheap compared to its ability to generate cash. Higher is always better.

Company Ticker Levered Free Cash Flow/
Enterprise Value
Kraft Foods KRFT 6.2%
General Mills GIS 5.1%
Campbell Soup CPB 3.3%
Kellogg K 2.1%
ConAgra Foods CAG 1.6%

Of the five peers, only Kraft Foods (KRFT) has a better ratio. You could buy Kraft instead — after all, it has a slightly higher dividend yield at 3.5% compared to 3% for General Mills. But GIS’ two recent acquisitions put it in a much better spot geographically, with 29% of revenue outside the U.S. compared to 16% for Kraft. Remember that Kellogg reported earnings that included slower U.S. business; geographic diversification is important.

Article printed from InvestorPlace Media,

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