General Mills (GIS -0.49%) is a large and iconic consumer staples company. But it isn't exactly correct to view it as a food maker, because what it really owns is a collection of brands that it manages. Brand-level results vary, but the end goal is to keep growing each brand's business over time.
General Mills' pet food division has been experiencing some pain of late, but this important division seems to be on the mend. Here's what's going on and why it is so important for General Mills.
Buying growth
General Mills bought Blue Buffalo in 2018. At the time, some industry watchers were concerned that the consumer staples giant overpaid for the company, which was the leading provider of healthy pet food. Management, however, believed that it could speed up Blue Buffalo's effort to move from the specialty store space into mass market outlets.
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Buying Blue Buffalo was all about the growth potential it offered to General Mills. Overall, the results have been exceptional, with General Mills expanding sales at Blue Buffalo at a compound annual rate of 15% between fiscal 2018 and fiscal 2022. This is exactly what adding a smaller brand with limited distribution can achieve when a larger company with more advertising and distribution clout buys it.
But even good businesses don't grow to the sky, with performance over time more likely to resemble a sine curve than a straight line. The best that can really be hoped for is an upward sloping sine curve. And that means that, sometimes, things will go wrong. That's exactly what the last couple of quarters have shown for Blue Buffalo.
Improving ugly numbers
There have been a couple of headwinds facing General Mills' pet food business. Inflation is a notable issue, though, to be fair, that's a problem for all companies today. Another has been supply chain issues, which are more company specific, as Blue Buffalo hasn't been able to meet product demand. Solving this required capital spending on new capacity, which impacts profits.
To put some numbers on what's been going on, Blue Buffalo had a strong fiscal first quarter in 2023. Organic sales were up 14% year over year while segment profits rose 7%. However, the company highlighted that it was facing capacity constraints in dry food and pet treats and dealing with higher costs.
From a big-picture perspective, price increases offset volume declines, but the environment was increasingly difficult.
In the fiscal second quarter of 2023, the bottom seemingly fell out. Organic sales flatlined year over year and segment profits declined 34%. That's a big problem, given that Blue Buffalo is expected to be a key growth engine for General Mills' overall business. Inflation and investment in new capacity were prominent issues, but the real standout was inventory reductions at retailers. That could have meant a temporary hit to sales or a shift away from the company's Blue Buffalo offerings.
The fiscal third quarter provided some welcome relief, with organic sales up 14% year over year and higher nearly 9% sequentially from the second quarter. Management noted that retailers rebuilt inventory and that Blue Buffalo increased service levels (at a simple level, it was able to fulfill orders thanks to added capacity). All in, it doesn't appear that General Mills' growth engine has sputtered to a halt. That's great news for investors.
But things aren't fully back to normal just yet. Notably, inflation and spending on new capacity left segment operating profit down 7% year over year in the quarter. General Mills is working price hikes through the system to combat inflation, which will just take time. But the double-digit sales growth for dry dog and cat food is a clear indication that Blue Buffalo remains a desirable product. Directionally, the pet food business seems to be back on track.
Still a key part of the growth story
Blue Buffalo has been a headline grabber at General Mills since the company acquired it. When the business hit a rough patch this fiscal year, investors had every right to wonder about the future of this growth-oriented business. Management stated that it was working on getting the division back on track as quickly as possible, with the fiscal third quarter showing fairly clearly that it is living up to that promise.
If you own General Mills, the ugly performance at Blue Buffalo of late is probably best viewed as a hiccup and not the start of a long-term downtrend. That means that the company's growth story is still a good one. Although the stock doesn't appear to be cheap today, if you are looking for a consumer staples company that is executing well in a tough market, General Mills might still be worth a closer look.
