Higher Profitability Offsets an Organic Sales Slip at General Mills

After emphasizing a vigorous plan to lift top-line sales during its annual investor day in July, General Mills (GIS -0.32%) fell short of its own goals in the first quarter of its new fiscal 2020 year. The company's financial statements, issued Wednesday before markets opened for trading, did reveal healthy profit, however, and management stressed that the full-year outlook for the consumer packaged-foods conglomerate is still intact.

General Mills: The raw numbers

As we parse the company's earnings release below, note that all comparison numbers refer to those of the prior-year quarter.

EPS = earnings per share. Data source: General Mills.

What happened this quarter?

• Organic revenue declined by 1% due to lower volume, which was partially offset by higher net price realization. This result trails management's forecast of a full-year organic revenue expansion pace of 1% to 2%.
• In the company's largest business division, its North America retail segment, sales were flat against the prior year at nearly $2.4 billion, as firmer pricing and improved product mix offset a decline in volume.
• General Mills' pet segment improved revenue by 7% to $368 million on volume growth, higher price realization, and favorable product mix. The company has now completely lapped its April 2018 acquisition of premium pet food manufacturer Blue Buffalo; healthy pet sales reflect the company's initial success in scaling the acquired brand.
• Convenience store and food service sales dipped 4% to $445 million, which management attributed to softer bakery flour sales volume and weaker pricing.
• The Europe and Australia business's top line declined by 9% to $454 million due to lower volume as well as foreign currency impacts. In the Asia and Latin America segment, sales fell 10% to $360 million. Five percentage points of this decline stemmed from prior-year divestitures, while lower volume and foreign currency headwinds accounted for the remaining 5%.
• While the lack of both reported and organic sales growth reflects a slow start to the fiscal year, the organization compensated by containing both product and administrative costs. Gross margin improved by 200 basis points to 34.7%, while selling, general, and administrative expenses (SG&A) dipped 20 basis points as a percentage of sales, to 17.9%. As a result, operating profit rose by 10% to $662 million.
• The higher operating profit, combined with lower interest expense due to debt reduction and a 40% decrease in income tax expense versus the prior-year period, resulted in the marked improvement in net earnings, as seen in the table above.
• General Mills' adjusted diluted EPS of $0.79 represents an 11% increase over the comparable quarter, exceeding the company's full-year outlook pace of 3% to 5% growth.

Image source: Getty Images.

What management had to say

Within General Mills' earnings press release, CEO Jeff Harmening placed the mildly disappointing revenue dip in context:

We are making clear progress in becoming a nimbler, more consumer-connected General Mills. Our first-quarter net sales performance included encouraging improvement in North America Retail and strong growth in [the pet segment] driven by good innovation and effective brand-building investment. We got off to a slower start in our other segments, and we're taking actions to drive top-line improvement for those segments and the company starting in the second quarter. On the bottom line, we delivered profit and earnings growth ahead of our expectations while continuing to invest in our brands and capabilities. We remain on track to deliver our fiscal 2020 goals, including accelerating our organic sales growth, maintaining our strong margins, and reducing our leverage.

Looking forward

As Harmening implies above, General Mills left its full-year outlook unchanged on Wednesday. We've already touched on the goals of 1% to 2% year-over-year organic revenue growth and adjusted EPS growth of 3% to 5%. As I discussed in my earnings preview, General Mills is also aiming for free cash flow conversion of 95% in the current fiscal year.

This simply means that it intends to produce free cash flow equal to at least 95% of adjusted net income in 2020. The organization is ahead of plan, as by my rough calculation, it achieved free cash flow conversion of 104% in the first quarter. Prodigious cash flow is a visible factor in General Mills' recent popularity as a consumer staples investment, and at least on this front, shareholders should be reasonably pleased with the results of the last three months.