The last 12 months have been great for “Magnificent 7” tech stocks and AI-related stocks, as the market appears willing to continually chase these names to higher highs. How much longer could this rally last, especially with Al names like NVIDIA (NVDA), it's anyone's guess, and it wouldn't be fun if and when the music stopped.
That's why a better idea for deploying new capital in this frothy market might be to allocate it to struggling sectors that were once market favorites, such as consumer staples. This strategy could provide downside protection to a portfolio if market sentiment becomes negative toward highly favored growth stocks and tilts toward defensive stocks.
This brings me to General Mills (NYSE:SIG), which saw its share price fall by 16.5% over the last 12 months. As shown below, GIS even underperformed the SPDR Consumer Staples ETF (XLP) over the past year. In this article I explain why Value and Income may want to consider piggybacking on GIS at the current discounted price, so let's get started!
Why a GIS?
General Mills is a global packaged food company home to many well-known brands of cereals, snacks, homemade meals, yogurt, baking mixes and pet foods, including Pillsbury, Cheerios, Betty Crocker , Nature Valley, Blue Buffalo and Haagen-Dazs. . Most of its business comes from the United States, with the remaining fifth coming internationally.
GIS has done a pretty good job growing revenue while maintaining its operating margin between 15% and 18% over most of the last decade, amid changing consumer tastes and preferences. As shown below, GIS revenue began to experience a recovery in 2018, with continued acceleration in recent years since the start of the pandemic in 2020.
This trend has slowed in recent quarters, however, as household purchases of certain items have reversed some gains from previous years. This is reflected in net sales falling 2%, to $5.1 billion, during GIS' most recent fiscal second quarter (ended November 26). This was driven by lower volume versus sterling, partially offset by favorable net price realization and a higher margin product mix. Organic net revenue was also down 2%, but it's worth noting that this comes after double-digit growth the year before. Taking into account the previous 2 years, GIS organic sales increased by 4% on a 2-year compound basis.
Despite GIS' recent major challenges, the company is experiencing favorable margin growth, with operating profit up 2% year-over-year in the fiscal second quarter, driven by favorable pricing and efficiency. COGS, as evidenced by an adjusted operating profit margin up 240 basis points. Over one year at 19.3%. GIS' size allows it to achieve margins at the high end of the consumer staples sector. As shown below, it earns an A- grade in terms of profitability with EBITDA and net profit margins of 20% and 12%, respectively, coming in at around 2x or more compared to the industry median.
Looking forward to the remainder of the financial year and beyond, I would expect continued margin improvement driven by GIS' Holistic Margin Management (HMM) plan, which aims to achieve a near-term high of 5% COGS savings this fiscal year, up from its previous target of 4%. As shown below, this represents a marked acceleration in COGS savings over previous years. For reference, cost of goods sold is a primary expense that is deducted from revenue to calculate gross profit, and lower COGS results in higher gross profit.
Thanks to the aforementioned cost management plan, combined with the anticipation of a favorable product mix, management expects annual EPS growth of 4-5% for the entire current fiscal year. This could reasonably be achieved given that GIS has the largest share of the dog food market through its Blue Buffalo brand and a top 5 position in cat foods and demand has proven to be inelastic to price increases of recent years. Management highlighted the performance of this business and its future prospects, as indicated during the last conference call:
It is important to note that in the five years we have owned the [Blue Buffalo] activity, we have doubled the activity. The Blue brand is really strong. When we do it well, whether it's life-saving formula or advertising or holiday treats or things like that, we find that the business responds really well. And it's very clear to us that this humanization trend is going to continue, and that Blue is well positioned to capture it over time.
Pet food may be an underappreciated category at GIS, given the strong growth in pet ownership in recent years as consumers have spent more time at home during the pandemic. As shown below, this market is expected to grow at a healthy CAGR of 3.6% by the end of the decade.
Risks to SIG in the near term include cost inflation, which could be exacerbated by recent attacks on trade routes in the Red Sea. This could impact some of the GIS ingredients such as Palm oil. Although some of its brands, such as pet food, have proven to be rather price inelastic, allowing GIS to pass on higher costs to consumers, it is unclear whether a price ceiling will be reached for higher input costs, which will cause consumers to reduce their sales at higher prices. cheaper store brands.
Additionally, higher interest rates could result in higher interest costs for GIS, although it maintains a BBB investment grade credit rating from S&P. The impact of rising rates is reflected in net interest expense of $118 million in the fiscal second quarter, compared to $92 million in the prior-year period.
GIS has maintained a stable net debt level between $11 billion and $12 billion since 2020 and has a TTM net debt to EBITDA ratio of 2.9x, just below the 3.0x level generally considered safe by credit rating agencies. rating. Management plans to maintain a leverage ratio below 3x while maintaining its share repurchase program. GIS has retired 7% of its outstanding shares over the past three years and earns a 7% return for every dollar spent on share repurchases, based on the current forward PE ratio of 14.2.
Meanwhile, GIS pays a respectable 3.7% dividend yield, well covered by a 51% payout ratio, leaving enough capital retained for debt repayment, brand investments and buybacks. actions. While the 5-year dividend CAGR is just 3.3%, growth has accelerated in recent years, including last year's 9.3% increase reported in June. It is therefore possible that another increase will be planned in a few months.
As for valuation, I see GIS worth at the current price of $63.71 with a forward PE of 14.2, well below its normal PE of 17.2. This also takes into account the 4-5% EPS growth estimate mentioned above for the current fiscal year and sell-side analysts who follow the company believe this will continue through fiscal 2026. believes this is achievable through cost rationalization efforts and the growth of GIS' premium brands. which demonstrated inelasticity to price increases.
Takeaways for investors
While General Mills faces near-term headwinds such as cost inflation and potential interest rate impacts, I believe the company's strong portfolio of well-known brands, focus on Margin expansion thanks to its HMM plan and strong dividend yield make it an attractive buying opportunity. at current levels. Additionally, with expectations of continued earnings growth and potential for share repurchases and dividend increases in the future, GIS offers long-term value and return potential for investors. With a dividend yield of 3.7% and a reasonable long-term annual EPS growth target of 5%, GIS could produce near market-level returns, all with a higher yield and lower potential volatility. As such, I consider SIG a “buy” at current prices.