Investors Found No Prize at the Bottom of General Mills, Inc. Earnings

General Mills stock - Investors Found No Prize at the Bottom of General Mills, Inc. Earnings

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Bad news for fans of Cheerios and General Mills, Inc. (NYSE:GIS) shareholders. General Mills stock fell to the tune of nearly 10% in response to earnings. GIS delivered a decent third-quarter report. But its profit outlook is lackluster — and could coincide with rising breakfast cereal prices. Cereal costs are on the rise across the board.

Even rival packaged food players like Campbell Soup Company (NYSE:CPB) and Kellogg Company (NYSE:K) fell on Wednesday following the report — with traders presuming they’re facing similar headwinds.

General Mills, however, is largely being pegged as the biggest victim of increased operation and production costs within the food arena.

GIS Earnings Recap

For its Q3 ending in February, General Mills turned $3.88 billion worth of revenue into an adjusted profit of 79 cents per share. Revenue was up 2% year-over-year, while earnings were up 10%. More important though, operating profits fell 6% on a constant currency basis.

Whatever the case, the top line was better than the $3.87 billion analysts were collectively expecting. And the bottom line was just a hair better than the profit of 78 cents per share of General Mills stock analysts had modeled.

The bottom line still fell short of the company’s goal though. CEO Jeff Harmening commented on the numbers:

“Our third-quarter operating profit fell well short of our expectations, and cost pressures are impacting our full-year outlook.”

General Mills’ business in Europe and Australia were notable problem areas. Though revenue was up 11% for the two markets, operating profits fell 36% mostly thanks to rising input costs. Profits generated by convenience stores and food-service customers also fell 10% due to inflation.

Looking Ahead for General Mills Stock

Last quarter’s shrinking operating profits may only be a taste of what’s to come if investors take General Mills’ outlook at face value. Full-year organic net sales are expected to be flat versus a previous growth outlook of 3%. Meanwhile, its operating profits are projected to fall between 5% and 6% on a constant currency basis thanks to higher operating and input costs.

Harmening added to his comments:

“Like the broader industry, we’re seeing sharp increases in input costs, including inflation in freight and commodities. Because of our improved volume performance, we’re also incurring higher operational costs.”

And analysts have taken notice. Three of them (so far) have lowered their price targets on General Mills stock, with RBC Capital Markets justifying the response by suggesting future GIS earnings would be “disproportionately impacted” by increased shipping costs related to ferrying goods from one facility to another.

General Mills is responding, aiming to cut costs by improving its distribution network and tweak margins where it can. That may create little benefit though, given that it has little control over the price of things like fuel and freight.

To that end, one can’t help but wonder if General Mills isn’t equipped to make such meaningful improvements. As J.P.Morgan analyst Ken Goldman opined:

“We are unsure how one of the biggest companies in the world, one with fairly predictable sales, could have a forecasting system with such inaccurate outputs.”

Analysts are also unsure that the company will be able to pass along more than a small piece of its cost increases along to consumers without losing them.

Bottom Line

The headwind General Mills is running into is neither a new one, nor surprising.

Freight prices ebb and flow, as do commodity prices. It’s a bit unusual to see both costs swell so much at the same time, but General Mills has seen and survived worse. Time brings all things into a sustainable balance.

It’s the “in the meantime” that can make owning General Mills stock a challenging exercise.

Trapped between competitors, suppliers and the transportation industry as well as distributors like Walmart Inc (NYSE:WMT) that are increasingly pushing their own private-label brands, General Mills is in a less-than-compelling position.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.

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