One of the nicest things about owning shares of a company like General Mills (NYSE:GIS) is you generally know what to expect. After all, there are few businesses as predictable as biscuits, frozen vegetables, and ice cream, a few of the many products General Mills sells. But that doesn't mean that things will always run smoothly.
While it may be one of the safer bets in the market, you still need to be aware of the levers that could hurt the business. Here are three things that could lead to a decline in General Mills' stock.
1. Input cost volatility
Enough analysts pay attention to this to make it worth mentioning. While I generally think it's tough to predict the direction of material costs and the impact they may have on this business, unfavorable conditions can mess with the stock short term.
The facts are that higher costs for grain, which is around 10% of General Mills cost of goods, will lower profits. Because of this, management engages in commodity hedges to try to smooth out the bumps. Unfortunately, there will be years when this practice works and there will be times when it doesn't. This ebb and flow of input prices may mess with the stock, but if you're invested for the long haul, the average price of materials (like grain) eventually even out.
2. Management loses touch and misses trends
Right now the two big things working in General Mills' favor are its performance in emerging markets and its focus on key customers. Last year, General Mills achieved double-digit growth in China. CEO Ken Powell said, "We are going to keep our foot on the gas in 2015." The plan is to expand its reach by efforts including offering more flavors of popular brands like Haagen-Dazs to more retailers in more Chinese cities. But if management tries to grow too fast, it risks aggravating new consumers with shortages and out-of-stock items.
Alienating your core customer is never good. General Mills has identified millennials, multicultural U.S. families, adults over 55, and the growing middle class in emerging markets as its key customers. So prolonged out-of-stock items, production delays, volume drop-offs, and other operational issues could prompt these consumers to replace General Mills' products with alternatives.
3. Priority platforms begin to lose steam
General Mills' six priority platforms are yogurt, cereal, snacks, mixes, frozen breakfast, and biscuits. Last quarter, revenue for all these products was up 5%. That's a solid number and shows the strength of the brands in those categories. While there are some issues, (like weakness in the yogurt category, particularly with Yoplait Light), brands like Betty Crocker, Cheerios, and Progresso are strong.
Going forward, if these types of products begin to lose market share, or if consumers are shifting away from categories like cereal, (due to more breakfast choices) the stock may suffer. Remember these types of foods are in General Mills' wheelhouse. Weakness here would mean weakness in the overall business.
Going back to yogurt, management claims that it is gaining ground in the all-important Greek yogurt category. But General Mills has raised prices to counter higher dairy costs. In the past, key competitor Danone has been able to hold prices in order to gain volume increases. Raising prices when competitors don't could hurt sales.
4. The Wal-Mart factor
According to Morningstar, 21% of General Mills sales comes from Wal-Mart. In fact, 53% of its domestic sales are derived from its five biggest retail customers. That opens the company up to risk.
Due to retailers' attempts to hold customers, these partners could try to squeeze General Mills on pricing. Worse yet, if they request better pricing or more promotions (and General Mills does not comply), it could result in less shelf space. A loss of shelf space would definitely hurt General Mills' volume and the top line. The other thing about losing shelf space is, once it's gone, it's very tough to get it back.
Foolish final words
Even for the most steady and stable businesses, things can and do go wrong and that can send the stock down.
For General Mills, these negative factors are pretty clear cut. If input prices get wacky, if management makes operational mistakes with key customers in key regions, and if the core business starts to weaken, the stock could suffer. Also if its largest retail customers get cranky, there could be repercussions. Whether you think these events are likely or not, it's always better to be in the know. A little preparation now could save a lot of pain later.
Wade Michels has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.