Pet Food Success Masks Trouble for General Mills

Food giant General Mills' (GIS 1.12%) stock rose about 2% after the company reported earnings on Dec. 18, 2019. The broader market, as measured by the S&P 500, was flat, so Wall Street seemed pleased by the financial results. And there were things to be happy about in the company's fiscal second-quarter 2020 earnings release. However, there were also things to be a little worried about, too. Here's the good news and the bad.

Going to the dogs

The single biggest piece of good news out of General Mills' financial results was that its pet food business grew 16% year over year on a material increase in volume. This is huge, because the packaged food company made a sizable bet on the space when it bought healthy pet food maker Blue Buffalo in 2018. Investors were concerned that it was paying a very high price for the company at $8 billion. General Mills' take was that it was paying for a high-growth business, and that future growth would make the price tag look much less onerous over time. This deal appears to be playing out as management hoped so far, and the quarter was one more example of the trend. 

Image source: Getty Images

To be honest, the logic of the Blue Buffalo purchase has always been pretty strong. Prior to being acquired, the company's products were largely available in specialty pet shops. It was only just starting to expand its distribution (into grocery stores, for example) when General Mills bought it. The latter has strong relationships with grocery and similar mass merchandise stores, so management believed it would be able to support and accelerate Blue Buffalo's growth plans. The real question was whether General Mills could execute on this plan. So far, it has.

This is doubly notable because some of the company's peers also gambled on pet food -- and the progress they are making hasn't been living up to expectations. For example, sales at J. M. Smuckers' (SJM 0.72%) pet food business declined 2% in the most recent quarter. The company highlighted the trouble, with the CEO noting in the earnings release: "Despite continuing softness for our premium dog food offerings, we were pleased with the performance for the balance of our portfolio." After a number of acquisitions, pet food is Smuckers' largest business, so any softness here is a pretty big deal. 

Clearly, General Mills' success in expanding the Blue Buffalo brand is good news, and it is executing better than some key peers. But pet food is still a relatively small business for the company (around 9% of sales), which has material operations in the cereal, snack bar, and yogurt niches, among others.

The rest of the business

While pet food was a bright spot, the rest of General Mills' portfolio wasn't nearly as strong. Cereal did well, with sales up 2% in the first half of fiscal 2020. However, this is a mature business that's facing serious headwinds as consumers have shifted away from eating the breakfast food. General Mills is doing well for sure, but that's largely coming at the expense of competitors, who appear to be losing market share. So the company is putting up okay results and focusing on things like product innovation in a cash cow business that may be in secular decline at the moment. At best, this is a mixed blessing. 

Management also highlighted that sales results in the company's snacks business improved in the fiscal first half, but that improvement was from down 4% in fiscal 2019 to down 1%. Better, yes, but not a great outcome. General Mills' large snack bar operation was the big drag, with sales down 3% in the first six months of the fiscal year, though that still marked an improvement from the 5% decline last year. Snacking is a sector that is seeing increasing competition, so getting this business back on a growth track is both important and likely to be increasingly difficult.

Data source: General Mills. Table by author.

Then there's the Yoplait yogurt business. General Mills pretty much missed the Greek yogurt craze a few years ago, as that style of yogurt took over the space. As a result, yogurt sales in fiscal 2018 were off by a whopping 11%. Management has been working its way back from this misstep, bringing out new products and refreshing older ones. But yogurt remains a soft spot, with sales down 3% so far in fiscal 2020, a worse showing than the 2% decline of 2019.

To be fair, not everything is going badly. Some of General Mills' major brands continue to perform well -- Progresso Soups and Old El Paso, for example, put up retail sales growth of 3% and 6%, respectively. And there really aren't any disasters in the mix like the fiscal 2018 yogurt performance, so it was, overall, a solid quarter, marked by a 12% bump in adjusted earnings per share.

However, the top line was flat. Ultimately, investors must balance the good news (like Blue Buffalo) and the weakness elsewhere in the portfolio (like yogurt and snacks) -- the company is hardly firing on all cylinders.

General Mills is a large and diversified packaged foods company, and there will always be a mix of good and bad in its portfolio. The hope is that, over time, the good will outweigh the bad, and sales and earnings will grow at a slow and steady pace. Management was looking to buy some growth when it added Blue Buffalo to its stable of iconic brands, and that's working out as intended. 

If you own the stock or are thinking about adding it to your portfolio, you need to recognize that General Mills still has some work to do as it looks to get back on a growth track. That's not a knock on the quarter or the company, it's just the reality of the situation.