For the better part of the past decade, General Mills (NYSE:GIS) has not been a strong performer. Changing consumer preferences and a large debtload have kept GIS stock from achieving outsized returns.
However, the novel coronavirus has given a boost to the food industry as a whole. As folks have avoided restaurants, they’ve spent more at the grocery store. That’s given a spark to General Mills and other packaged foods players. With that positive impact starting to fade, however, it’s time to reconsider General Mills. Shares are likely to cool back off in coming months.
Here’s why.
A Stagnant Business
Since 2013, General Mills has traded around $50 per share, give or take a few bucks. It briefly spiked up above $70 in 2016 during a flight into dividend-paying stocks. And on a few occasions, the stock dipped to $40. In general, however, $50 has been its average in recent years.
It was again trading around there prior to the coronavirus. But thanks to the sales boost from stockpiling, General Mills advanced back above $60.
Unfortunately, there’s nothing happening with the business to justify this momentum. For the fiscal year that ended May 2012, General Mills pulled in $16.7 billion of revenue. Over the past 12 months, it earned precisely $16.7 billion of revenue. That’s a dreary performance. You’d at least hope to keep up with inflation, but General Mills couldn’t even manage that.
Making matters worse, the company had a large acquisition in there, but it still wasn’t enough to generate overall revenue growth.
Soggy Products
That gets at the heart of the problem for General Mills. At its core, the company is (or at least historically was) a famed maker of breakfast cereals. And that’s been a declining industry; cereal sales never recovered to pre-2008 levels.
There are various factors behind that. Consumers have looked for low-carb and gluten-free options, both of which are bad for cereal companies in general. The rise of protein-focused dietary trends has boosted consumption of eggs, meat and other breakfast alternatives. Millenials don’t like cereal. And the diabetes epidemic has caused people to curtail consumption of sugary products, including many breakfast cereals.
General Mills also has a big yogurt franchise. However, there too, it stuck to traditional sugar-laden product lines. In the interim, rivals such as Danone (OTCMKTS:DANOY) introduced healthier Greek yogurt product lines that took market share.
Blue Buffalo or White Elephant?
General Mills tried to solve its stagnation by making a transformative acquisition. In 2018, it shelled out a shocking $8 billion for the Blue Buffalo line of healthy pet food products. Animal ownership is a huge secular growth market in the U.S. As the rate of childbearing has gone down, Americans have increasingly turned to pets for companionship. Logically, companies have figured that pet food would be a big industry.
However, it seems folks got a bit too aggressive. SJ Smucker (NYSE:SJM) spent $6 billion on Big Heart Pet Brands four years ago. That acquisition almost immediately underperformed, and Smucker stock has gone on to trail its food peers.
The General Mills purchase was more recent, but appears to be heading down the same path. $8 billion was simply a gigantic price tag for Blue Buffalo which, even now, is generating less than $2 billion per year in revenue and is only growing in the single digits annually.
Pet food is not a tech growth industry. When you pay huge sales multiples, it’s hard to recoup your investment.
Balance Sheet Slows GIS Stock
That Blue Buffalo purchase set General Mills back in another way. It’s bad enough to make a huge acquisition and see your overall revenues fail to go up. But that deal also mortgaged the company’s treasury. It now finds itself with nearly $14 billion of long-term debt. By contrast, it has just $4 billion in cash and current assets, and it generates around $2 billion per year in net income.
While the debt isn’t crippling at this point, it’s still a large burden. Particularly if credit markets tighten up, investors could ask questions about General Mill’s long-term financial outlook.
Many people, I’d guess, if they could do it over would rather give up the $1.5 billion or so that Blue Buffalo generates in revenues annually in return for paying off $8 billion of that massive debt pile.
GIS Stock Verdict
The Blue Buffalo deal shows the challenge that many packaged foods companies face. Their core products aren’t necessarily trendy or appealing to millenials and other younger consumers anymore. This forces them to take increasingly dramatic actions – such as dropping $8 billion on a pet food company – to try to get revenue growth.
While General Mills can handle its debts and pay the dividend for years to come, it’s hard to see how there will be much growth for GIS stock. The company is struggling to even hold revenues flat all while it piles up more and more debt. General Mills’ long-term debt has nearly doubled since 2013 while revenues have been flat as a pancake. This is not a formula for strong investment returns over the long-term.
I get the appeal of General Mills as a holding during the pandemic. Food stocks still work as a safety trade.
But there are better options in the food space. Some food companies still have reasonable organic growth figures and have products that appeal to younger consumers.
That said, if the economic recovery story continues to play out, many cyclical and consumer discretionary stocks will outperform the food names altogether. Add it all up, and it’s about time for GIS stock to fall back to its usual territory around $50 a share.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned DANOY stock.
