General Mills (GIS 0.99%) is one of the food industry's biggest and most iconic names. Its size and its brand popularity helped this consumer goods maker generate enough free cash flow to afford a generous 2.8% dividend yield and elevate the company to a $45 billion market cap.
Like all of its peers, General Mills is working to manage rapid increases in input costs. Recently, the company released its fiscal first-quarter 2023 earnings (for the quarter ending Aug. 28). That report offered solid evidence that General Mills is getting a handle on this financial headwind.
General Mills is rolling down a rough road
It hasn't been easy to be a food maker over the past year or so. Even with a great stable of iconic brands like Cheerios and Betty Crocker (among many others), General Mills still deals with the rising costs of ingredients, the pay increases for employees, and the elevated price of shipping goods to its customers. Clearly, inflation is causing havoc with company profitability in this consumer staples segment.
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There are a couple of core ways for businesses to deal with inflation. One is to cut costs, which is something that General Mills worked on. Another is to increase prices, which it also did. On the latter front, it has been, like most of its peers, pretty aggressive. In the fiscal first quarter of 2023, organic price increases were in the 15% range year over year. When you raise prices that much, you lose some customers. The price increases were offset by organic volume declines, which pulled 5 percentage points off of the price increase, leaving organic sales growth at 10%.
The end result in Q1 is actually a pretty good number, but it shows the trade-off companies have to make. Some customers facing rising costs will opt for alternatives that are cheaper, like generic store brands. But even store brands are increasing prices, so relative price differences probably haven't changed all that much.
The margin squeeze is the big issue
The big problem for food makers like General Mills is that there's a time lag between when input costs increase and when those rising costs get passed on to consumers. That time lag worries some investors that margins will contract and keep contracting. Wall Street far too often extrapolates current trends far into the future and creates false impressions.
However, General Mills' first-quarter 2023 earnings contained other upbeat data that need to be factored in before Wall Street generates warnings of despair. Notably, adjusted gross margin actually increased 20 basis points year over year, while adjusted operating profit margin increased by 70 basis points.
To be fair, neither of the margin increases was exactly huge. However, the fact that General Mills was able to stabilize its margins despite ongoing inflationary headwinds speaks volumes about the efforts management has made to protect the business. Essentially, General Mills' price increases appear to have caught up with the price increases. One quarter doesn't make a trend, so investors will need to monitor the company's margins over the next few quarters to see if this was an anomaly or if it actually points to a trend.
Unless margins contract materially from here, however, it appears that General Mills is making notable progress in its efforts to pass costs through to consumers. There's just no easy way to do this, either. It is a hard move that often has to be followed up with efforts to woo back consumers who defected to cheaper alternatives. But General Mills is clearly seeing some early success in this effort.
General Mills is hoping this is the start of a turn
Inflation is still running hot today, but consumers have so far been willing to accept higher prices in relative stride. General Mills' ability to improve its margins year over year is a sign of its success on the pricing front, more than offsetting the impact of volume declines. If it can continue to protect its margins, the worst could actually be behind this food maker. And that's a good sign for the broader industry as well.
