As concerns about tariffs and rising interest rates hammer the markets, many investors are pivoting toward defensive stocks that withstand market downturns better than higher-growth stocks. Packaged foods giant General Mills (GIS 0.01%) is usually one of those stocks -- but its 35% decline this year likely spooked conservative investors.
However, that sell-off reduced General Mills' forward P/E to 12 and boosted its forward dividend yield to 5.2%. Do those figures indicate that it is now an undervalued income stock that has finally bottomed out?
Image source: Getty Images.
General Mills' dividend and valuation
The company has raised its dividend annually for 14 straight years. During the first six months of fiscal 2019, it spent $589 million, or 52% of its free cash flow, on its dividend payments. That low payout ratio leaves it plenty of room for future hikes.
General Mills also pays a higher dividend than its rivals Kellogg (K +0.00%), Mondelez International (MDLZ +0.99%), and Conagra (CAG +1.45%). The only major packaged foods rival paying a comparable yield is Kraft Heinz (KHC +1.12%) -- which has a forward valuation similar to General Mills.
|
Company |
Forward Yield |
Forward P/E |
|---|---|---|
|
General Mills |
5.2% |
12 |
|
Kellogg |
3.7% |
14 |
|
Mondelez International |
2.4% |
17 |
|
Conagra |
2.8% |
12 |
|
Kraft Heinz |
5.3% |
12 |
Source: Yahoo! Finance, as of Dec. 20.
Grading its core business
General Mills owns a massive portfolio of well-known brands, like Cheerios, Yoplait, and Haagen-Dazs. But it has struggled in recent years as consumers have pivoted away from its core brands -- especially sugary cereals -- toward healthier alternatives. To counter that shift, General Mills bought healthier brands like the organic food maker Annie's, and expanded into the premium pet food market with its takeover of Blue Buffalo Pet Products.
General Mills' revenue rose over the past year, but much of that growth was fueled by acquisitions. On an organic basis -- which excludes acquisitions, divestments, currency fluctuations, and other one-time charges -- its growth remains sluggish.
|
Q3 2018 |
Q4 2018 |
Q1 2019 |
Q2 2019 | |
|---|---|---|---|---|
|
Reported sales |
2% |
2% |
9% |
5% |
|
Organic sales (decline) |
1% |
1% |
0% |
(1%) |
Year-over-year growth. Source: General Mills quarterly reports.
The Blue Buffalo deal, which closed in the fourth quarter of 2018, clearly boosted its sales growth in the first half of 2019. However, that $8 billion acquisition, its integration costs, and higher input costs weighed down its margins.
Last quarter, General Mills' gross margin fell 20 basis points year over year to 34.2%, and its operating margin tumbled 450 basis points to 12.4%. But on an adjusted basis -- which excludes certain one-time items -- its gross margin rose 10 basis points to 34.5%, as its operating margin climbed 40 basis points to 17.3%.
For the full year, General Mills anticipates flat to 1% growth in organic sales, and for its reported revenue to rise 9% to 10% on a constant currency basis. It expects its constant-currency adjusted EPS to be flat to down 3% for the year. On a reported basis, analysts expect General Mills' earnings to fall 2%.
This group can help Blue Buffalo boost revenue. Image source: Getty Images.
Understanding the catalysts
General Mills' growth rates look anemic, but it could benefit from two potential tailwinds after it moves past the near-term headwinds.
First, pet products represent a recession-resistant market, since people still prioritize their pets' health during economic downturns. General Mills' Pet revenue fell 7% annually on a pro forma basis during the second quarter, but that was mainly due to a tough comparison with the prior-year quarter, when Blue Buffalo launched new products. But when we cut through the noise, the Pet segment's year-to-date retail sales still rose 9%.
Second, affordable products usually make a comeback against hip brands and organic foods when the economy slows down. Rebounding interest in General Mills' flagship brands, particularly in the tough North American market, should support its core business as it expands its portfolio.
So is it time to buy General Mills?
General Mills' low valuation, high dividend, and well-diversified business model should limit the stock's downside at these levels. Therefore, I'm willing to start a position in this defensive recession-resistant stock at these levels -- but I'd only start with a small position in case the stock tumbles further.
