Shares of General Mills, Inc. (NYSE:GIS) are tumbling Wednesday after the company posted disappointing first-quarter earnings before the market open. GIS stock is down nearly 6%, hitting a two-year low in the process.
There’s good reason for the decline. Both earnings and revenue missed consensus estimates badly. But the concerns with GIS stock go beyond the numbers.
General Mills looks to be in an increasingly difficult spot, particularly as its cereal business continues to struggle with changing consumer tastes. Meanwhile, several aspects of the company’s plan to deal with that lower demand, and other headwinds, seem directly contradicted by the first-quarter results.
General Mills did reaffirm full-year guidance. The company continues to forecast improving results as the year goes on. But today’s selloff shows the market simply doesn’t trust that outlook. That creates both risks and opportunity in GIS stock.
General Mills Earnings and Guidance
The headline numbers for General Mills’ Q1 look rather disappointing. Adjusted EPS of 71 cents declined 9% year-over-year, and missed Street estimates by a full 5 cents. Organic net revenue declined 4%, about half a point worse than analyst forecasts.
That in and of itself seems like a problem — but perhaps not enough to drive a 6% decline in a generally low-volatility stock. And General Mills did reaffirm full-year guidance across the board.
That guidance, however, requires a rather sharp acceleration over the rest of the year. General Mills still is projecting organic sales to decline 1-2% for the year – which implies just a 0-1% drop for the final three quarters. That’s a major improvement against the -4% performance seen over the past five quarters (including fiscal 2017). Operating margin for the full year is supposed to increase, despite a surprising, and disappointing 210 bps compression in the first quarter.
Investors obviously are skeptical, focusing more on the quarter’s results than the year’s projections. And looking at the quarter closely, it’s not hard to see why.
Revenue Problems for GIS Stock
On the top line, there’s simply a question as to whether General Mills can grow at all. Cereal demand continues to decline, with General Mills cereal sales falling 2.1% last year and 1.4% the year before, according to its 10-K. At its Investor Day, General Mills said one of its key priorities for 2018 was to grow that business. Instead, revenue fell a stunning 7% year-over-year.
Management did cite inventory reductions at key customers, and cited just a 1% decline at retail. But those inventory reductions – and retail pricing pressure – are likely to persist. Major grocers like Kroger Co (NYSE:KR) are reeling from the recent acquisition of Whole Foods Market by Amazon.com, Inc. (NASDAQ:AMZN) and pricing reductions at Wal-Mart Stores Inc (NYSE:WMT). That is going to pressure inventory – and potentially lead grocers to push more private-label brands, which generally offer better margins.
The larger problem is the yogurt business. Yogurt sales declined over 18% in two years between FY15 and FY17. Improving that business was another key goal for General Miss this year. Instead, U.S. sales fell double-digits in Q1, with declines cited overseas and in convenience stores as well. Clearly, Yoplait is losing share to privately held Chobani amid the “Greek yogurt” craze, with its own products not keeping up.
Cereal and yogurt combined are nearly one-third of General Mills revenue — and both categories are ailing badly. It’s hard to have much optimism toward GIS stock as long as that’s the case.
Margin And Valuation Problems, Too
Meanwhile, margins disappointed — and investors don’t trust that they will improve. There’s good reason for that. At the least, it’s difficult to improve margins amid declining revenue. General Mills has been able to do so through cost savings of late — but that can only last for some long. At some point, revenue needs to grow in order to leverage expenses.
The big margin concern in Q1 is that gross margins compressed 230 bps. General Mills managed to cut operating expenses to match the revenue decline — but higher input costs, per the Q1 release, drove the gross margin compression. And that is not something that General Mills can fix. If those costs continue to rise, General Mills will not be able to pass higher pricing along to consumers. There’s too much pricing pressure in the grocery space and too much private label competition for Cheerios prices to spike 5% or 10%.
The broader point is that General Mills’ biggest problems appear beyond its control. Demand is moving away from cereal, and away from Yoplait. Input costs are rising. And yet GIS stock doesn’t look particularly cheap, by any measure. Full-year EPS remains guided to about $3.12 or so. Even if General Mills hits that target — and, again, investors clearly don’t believe it will — it trades at about 17x forward EPS.
That’s a multiple that suggests a growing business — but this doesn’t look like a growing business. And until that changes, GIS stock may have more room to fall.
As of this writing, Vince Martin has no positions in any securities mentioned.