General Mills: Short-Term Downgrade After Significant Outperformance (NYSE:GIS)

Revisiting Successful GIS Coverage

In my first coverage of GIS two months ago in June, I argued that it is not suitable for a portfolio aimed at seeking Alpha. GIS serves different purposes, being highly uncorrelated with the overall market, as evidenced by its raw Beta factors hovering around zero. Therefore, I argued that GIS was a Buy at that time due to its fair valuation, not for long-term outperformance but rather for portfolio stabilization, given its adequate dividend yield, which I considered an inflation-protected income.

The portfolio stabilization and uncorrelation with the overall market have proven exactly right, with significant short-term outperformance during market turbulence. Since my last coverage, GIS has yielded a 9.5% total return, compared to 2.6% for the overall market. However, since I maintain that Alpha is not an argument for GIS, and considering the disappointing quarterly results since then, I believe this short-term outperformance was due to its anti-correlation and temporary risk-off sentiment. This could make a current entry questionable. However, my long-term Buy remains unaffected.

The Right Pick For Market Turbulence

GIS has recently proven its role as a portfolio stabilizer during market turbulence. See below observations based on daily data points since June. As expected, GIS showed a very slight negative correlation of -0.38 with the S&P 500. More importantly, GIS was significantly positively correlated with the VIX. As this unofficial “fear gauge” spiked, GIS rose sharply (correlation +0.61). The same trend is evident with the CNN Fear & Greed Index, where GIS is negatively correlated at -0.56. This means that as the index shifted down towards fear, GIS increased significantly. Now that both the VIX and the Fear & Greed Index have calmed down, the question of the fundamental justification for GIS’s elevated price level arises. Therefore, we will next look at the valuation, followed by an analysis of the fundamentals based on the recent quarterly results.

Dividend – Main Argument For GIS

With its recent surge, the dividend yield decreased from 3.6% to 3.4%, moving closer to its five- and ten-year averages of 3.2% and 3.3%, respectively. In my first article, I compared this with inflation-protected TIPS yields, which were then at 2.2%, giving GIS a 1.4% equity premium when considering only the dividend and excluding growth. Those 30-year real interest rates (TIPS) now stand at 2.0%. So, against a 3.4% GIS dividend yield, the 1.4% equity premium in this simplified and isolated view remained unchanged.

I also updated my point-in-time cost of equity for GIS from 6.4% at the time of my last analysis to a lower 6.0% due to lower 30-year yields (4.1% vs. 4.4%) and a slightly lower Blume-adjusted beta (0.38 vs. 0.40). Comparing this to the current 3.4% dividend yield, GIS would need 2.6% nominal annual growth as of today – only slightly higher than long-term inflation expectations.

Is The Inflation Protection Thesis In Doubt?

See below an update to my previous article’s analysis, once again highlighting that GIS’s top-line growth is highly correlated with inflation, with a one-year time lag. Keep in mind that these are per-share growth rates, which are also influenced by the share count. Growth rates based on absolute numbers would still show correlation, albeit slightly less. For example, FY2024’s 2.5% per share revenue growth is largely driven by buybacks, as on an absolute basis, revenue shrank by 1.2%. However, the correlation with inflation on the top line appears to hold strong, at least in the long-term, although GIS has recently suffered volume and price declines, which I will explore further later.

Below you can see how the share count had a noticeable impact on EPS in most years.

Q4 Showed Significant Headwinds

In Q4-24, ending in May, General Mills faced significant challenges, with sales down 6% and both adjusted operating profit and EPS falling by 10%. This was due to a 4% decline in pricing or mix and a 2% drop in volume. While volume declines have been common over the past three years, they were typically offset by substantial price increases, indicating favorable price elasticities. However, this last quarter shows that this approach may have been stretched too far, as pricing no longer seems to favor consumer staples. See below a chart from Seeking Alpha analyst Vladimir Dimitrov, CFA, from this article (link), which illustrates this well.

For the full year 2024, this translates to a slight 1% decline in revenue and mid-single-digit increases in adjusted operating profit and EPS, in line with the company’s previously updated outlook. Analyst EPS estimates were roughly met, while revenue fell short of expectations. For the upcoming year 2025, GIS anticipates essentially flat development across all metrics. The company faces value-seeking behavior from customers and views organic revenue growth through increased competitiveness as its top priority for 2025. Additionally, the North America Pet segment shall grow again due to accelerated humanization and the promotion of superior ingredients. Free cash flow conversion is projected to remain high at 95%.

For more insights on key risks and fundamentals, please visit my previous article, which remains largely relevant as it focuses primarily on long-term analysis.

Cautious Recovery In Sight

The reduced price levels can certainly be seen as a response to the general inflation trend, especially as inflation has significantly eased. GIS, for instance, was disproportionately affected by decreasing inflation in 2016 and 2017 as well, as highlighted in my earlier analysis on inflation correlation. Conversely, revenue growth tends to be disproportionately strong during periods of rising inflation. Thus, the current situation aligns with a normal, historically consistent trend. Additionally, it’s not just a company-specific issue. The currently quite low food-at-home inflation rate of only 1.1% supports this. On a positive note, retail channels tracked by Nielsen showed improving sales trends for General Mills in July and August.

HOLDING After A Successful Buy In June

This personal Hold rating should be taken literally. It reflects my position after having added shares in GIS as a long-term income play in June and being satisfied with the current portfolio size – hence, holding. The valuation remains reasonable, and current operating headwinds are consistent with historical correlations with inflation, suggesting no major red flags. However, it should be closely monitored when considering a new purchase. Over the past two months, GIS has significantly outperformed the broader turbulent market, fulfilling its stabilizing role as a risk hedge. Therefore, I would exercise caution with additional purchases in the short term. Long-term, GIS remains a Buy as a conservative, income-oriented portfolio component.