Morningstar Magazine - June/July 2018 - 87

Brand-Name Benefits
General Mills should overcome center-store challenges.

BEST IDEAS: EQUITY

Sonia Vora

General Mills GIS

This article is adapted from a Morningstar equity research report dated
March 19, 2018.

Stats 03/31/2018

General Mills GIS enjoys a wide moat formed by intangible assets and
cost advantages, and we expect the firm's returns on invested capital to remain
above its cost of capital (even in a bearish scenario) over the next 20
years. General Mills has leading share across several domestic food categories,
including ready-to-eat cereal (17% of revenue; 30% market share), where
it owns three of the top five brands in the United States, and yogurt (15% of
revenue; 18% market share). While we expect General Mills' positions in
these categories to remain strong, we think its exposure to the center of the
store, which has faced declining traffic the past several years as consumers
increasingly shop for fresher alternatives in the perimeter, has pressured its
brand intangible assets. This dynamic is evidenced by its cereal sales,
which have averaged 3% declines the past three years, in line with the lowto mid-single-digit declines of the category. Large food manufacturers
also contend with mounting pressure from niche players. As evidence, General
Mills' share in yogurt has slipped to below 20% from above 25% in 2010,
which partly reflects the firm's slow response to trends like Greek yogurt that
nimble upstarts foresaw.
However, the acquisition of natural pet food manufacturer Blue Buffalo stands
to prop up the firm's top line, as humanization and premiumization trends
have fueled 5% compound annual growth for U.S. pet food sales over the past
decade, without compromising its efforts to strengthen its bottom line.
We expect the wholesome natural category to gain share of overall U.S. pet
food, and for Blue Buffalo's position of this category to remain solid,
with more than a third of share. General Mills is targeting $750 million of
annual savings (including $50 million of synergies from the Blue Buffalo deal),
or around 6% of General Mills' fiscal 2017 cost of goods sold and operating
expenses, excluding depreciation and amortization. This should free
up resources to bolster its brand spending, which we view as crucial for the
company to restore top-line growth. We expect the firm's combined
expenditures on advertising and research and development will average above
7% of sales over the next decade, 130 basis points above its five-year
historical average. These investments should help the firm launch new
or reformulated products that better resonate with consumers and justify the
value (and therefore pricing) of its offerings over private-label fare.

Morningstar Rating
QQQQQ

Sector
s Consumer Defensive

Industry
Packaged Foods

Price
$45.06

Fair Value Estimate
$59.00

Uncertainty
Low

Economic Moat
Wide

Stewardship Rating
Standard

Market Cap
$25.8 Billion

Price/Fair Value 03/31/2018

$80
Month-End Closing Price

70
60
59.00
Fair Value Estimate Per Share

04/2015

04/2016

50
45.06
40
04/2017

We recently trimmed our fair value estimate for General Mills to $59 from $61
to incorporate near-term gross margin pressure from supply chain cost
inflation, with our gross margin forecast now averaging around 35% through
fiscal 2020 (versus above 36% prior). Our valuation implies a fiscal 2019
price/adjusted earnings multiple of around 19 times. Our forecast calls for 3%
sales growth, on average, from fiscal 2020 to fiscal 2027, with volume driving
roughly 60% of these gains. While we expect General Mills to face challenging
center-store category dynamics, we think its efforts to divert resources
to its faster-growing brands and refresh its yogurt and cereal businesses will
allow for a modest improvement in top-line momentum, allowing food
sales to average 1% to 2% growth over the next five years. We forecast average
operating margins around 18.5% over the next 10 years, or 80 basis points
of expansion from fiscal 2017. K
Sonia Vora is an equity analyst with Morningstar Research Services.

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Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018