General Mills (NYSE: GIS) the US-based branded consumer food company faces a challenging 2022; admittedly, food and beverage stocks in general haven’t had the best of times (the popular food and beverage ETF – FTXG is down year-to-date single digits), but GIS’s The underperformance was even more pronounced. We’re only a third of the way into the year and expecting GIS to recoup all the losses may be asking a lot, but we think the worst is over and the outlook is likely to change from there.
Let’s expand on some of the underlying subthemes behind our more optimistic stance.
Financial Outlook and Valuation
The U.S. consumer environment isn’t necessarily the most resilient, and even then, the consumer staples industry isn’t the fastest-growing sector.despite this Still, we see many encouraging factors in the future of GIS.
First, note that the company’s long-term “organic” net sales target is only 2-3%, but the expected growth rate for the May 2024 fiscal year is higher at 3-4%.
GLast year’s gross margin was quite strong at 34.2%, up 120 basis points from the previous year, but management believes it can build on that in the coming year as well. Productivity levels in the pet industry are in a better position and some of the pricing moves that were made across the business last year will also be reflected this year. FRED’s data shows that food manufacturers’ PPI did not really fall sharply, but continued to stabilize, reflecting the strength of pricing.
Crucially, past supply chain disruptions are unlikely to have a significant impact on GIS’ cost base. All these factors put the company in a better position to achieve 4% HMM (Holistic Margin Management) cost savings at the COGS level.
All in all, if we look at the consensus estimates for GIS over the next two years, we’re pretty excited about the impending improvement in operating leverage. GIS’ EPS growth (3.1%) is expected to outpace net sales growth (non-organic growth) by 30 bps in the year ending May 2024, with the gap between top and bottom lines widening further the following year To 400 basis points, GIS is expected to achieve EPS growth of nearly 6% YoY!
Given the likely improvement in operating leverage over the next two years, we see this as a good opportunity to buy the stock at a discount. Based on May 2025 EPS forecasts, the stock trades at just 14.4 times forward earnings, a 17% discount to its five-year average.
cash generation and dividends
A potentially better profit trajectory also enables GIS to better generate more cash. The company’s long-term goal is to convert 95% of its adjusted after-tax earnings into free cash flow. Last year, however, their conversion rate was far below that, at 80%.
For the coming year, management has publicly indicated that free cash flow conversion may return to its long-term target of 95%, largely driven by better supply chain visibility, which in turn facilitates better inventory management. As can be seen in the chart below, days of inventory are currently 10% higher than normal and should decline over the next few quarters.
Some investors may have been wary of the challenge of inventory drawdowns at retailers in North America, but on the fourth-quarter conference call, management was quick to point out that the issue isn’t just specific to GIS and is unlikely to persist.
Still, better free cash flow generation also increases the prospect of quality distributions, as GIS aims to return 80-90% of free cash flow to shareholders. Just to put it in perspective, also consider that this is a business whose dividend growth has trended upwards over time; most recently in July, the company raised its dividend by 9% from the previous 6%, making the Impressive. Investors also get a more attractive yield (3.45%) thanks to the big upside, about 30 basis points above the stock’s 4-year average yield.
Conclusion: Risk Reward and Hedging
If we look at GIS’ monthly price imprint, we can see that the stock is currently in poor shape, but that could change soon. First of all, please note that from November 2021 to May 2023, the stock has been rising in the form of a narrow upward channel.
In June, we saw the channel break down with a large red body candle. Since then, the sell-off has continued, with no sign of ending the downtrend. Barring a major event in the next two days, August will almost certainly be the fourth month in a row to close below the month’s open. This gives you an idea of how strong the selling momentum is.
Having said that, we think the stock may be close to bottoming as it is not far from testing the $63-67 area. Why is this area important? Well, if you look at the period May 2020 to June 2021, you will see that this terrain is a point of resistance (the area highlighted in yellow); in H1-22 we see the same terrain again as Sources of support, some long-wicked candles highlight the presence of bargain hunters. Basically, the takeaway here is that price usually bounces off this area, so don’t be surprised to see this area become a pivot area again.
The weakness for much of the year also means that GIS now looks more mean-reverting than other options in the consumer staples space. The chart below highlights that GIS’ relative strength ratio as a function of major stocks is about 24% away from the midpoint of its long-term range.
We also think GIS’s growing status as a potential hedging tool for the broader market is worth mentioning. The market has performed relatively well so far in 2022 (~17% return), but September has traditionally proven to be the worst month of the year (according to data going back to 1945). Recent macro data also suggest that the economy may be close to peaking, while broader market valuations do not fully reflect these risks.
Nonetheless, the chart above highlights how the stock’s sensitivity to the broader market has declined over time. Also, interestingly, of the 48 packaged food stocks around, GIS has one of the lowest sensitivities, making it one of the excellent defensive hedges.