From our vantage point, the narrow-moat company's tepid sales performance is being hampered by the decision to ratchet back brand marketing.
Erin Lash, CFA
09:49 AM | Email Article
’ third-quarter results (a 5% decline in organic sales, a 20-basis-point uptick in adjusted gross margins to 35%, and a 100-basis-point increase in adjusted operating margins to 16.9%) generally aligned with the updated outlook provided last month. As has been the case, management again attributed the bulk of the retraction to lackluster sales within its yogurt and soup operations--which we estimate in combination account for around one fifth of its total sales--as evidenced by the 7% top-line erosion (driven by a 9% shortfall in volumes) of the North American retail segment (two thirds of sales).
Erin Lash, CFA, is a director of consumer sector equity research for Morningstar.
Beyond ensuring that new products are aligned with evolving consumer trends in the face of intense competitive pressures, we still think its tepid sales performance is being hampered by the decision to ratchet back brand marketing--media and advertising spend slipped 8% in the third quarter, following a 20% drop in the second quarter. As we’ve articulated previously, we portend that a pullback in brand spending has artificially inflated profit levels across the industry, and we viewed recent outsize profit gains as unsustainable. From our vantage point, firms throughout the space will need to bolster brand spending to offset intense competition (while also ensuring that its brand intangible assets persist longer term), a sentiment to which General Mills has provided credence. In this vein, our forecast calls for marketing to exceed 5% of sales the next 10 years, 40 basis points north of its average the past three years.
While we intend to review our assumptions, we don’t foresee a change to our $58 fair value estimate or our longer-term outlook--sales gains of 3% and operating margins around 20%, about 400 basis points above the historical five-year average (reflecting efforts to extract inefficiencies). Shares trade in line with our valuation, and we’d suggest investors await a larger margin of safety before building a position in this narrow-moat name.
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