Goldman issues sell recommendation for General Mills

by Josh Sosland
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General Mills Yoplait yogurt
Jason English, managing director at Goldman Sachs, described yogurt as a “prime example” of a vulnerable category at General Mills.

NEW YORK — Amid sluggish sales trends and market share losses at General Mills, Inc., Goldman Sachs has downgraded to a “sell” its investment recommendation for the Minneapolis-based food company. Factors behind the guidance could apply to numerous companies across the packaged foods industry.

In a May 23 update by managing director Jason English, Goldman lowered its assessment of General Mills, Inc. from “neutral,” with a 12-month price target of $58. In trading May 24 on the New York Stock Exchange, General Mills shares closed at $62.37, down 33c, or 0.5%. The price was not far beneath the 52-week high of $65.49 set in early April.

An expectation that commodity price weakness may have largely run its course adds to concerns about prospects for General Mills in the Goldman analysis.

Jason English, Goldman Sachs
Jason English, managing director at Goldman Sachs

“A tide of tailwinds for the food industry has begun to subside as rates, which have inflated valuation, find a floor and commodities, which have flatter margins, cycle lows,” Mr. English said.

The commodity price situation compounds the problem of sluggish revenue growth, he said.

“The top line is under pressure, and U.S. Retail, which drives nearly three-quarters of the company’s operating profit, is witnessing weakness and share losses across categories,” Mr. English said.

He described yogurt as a “prime example” of a vulnerable category at General Mills. In addition to market share already lost, he said pending stock-keeping unit rationalization will prolong the losses.

A plus for the company is a promising outlook for General Mills’ International segment, poised to benefit from easing foreign exchange pressures. Still, as aggregate business pivots away from the United States, margins overall will suffer since international margins of 9.4% are less than half the U.S. Retail segment’s 22.5%, he said.

Sales trends for the U.S. business are not likely to improve, Goldman said.

“Looking forward we expect more of the same as we model limited organic growth,” Mr. English said. “After several periods of s.k.u. proliferation, General Mills is likely to face headwinds going forward as s.k.u. rationalization efforts, which have only recently begun, continue. Struggles in key categories persist as market share losses continue to mount and the most recent Nielsen data suggests that there is a broad-based share loss across most categories for General Mills.”

Goldman Sachs is forecasting persistent declines in U.S. Retail sales (excluding acquisitions) through fiscal year 2017 (year ends May 31) before stabilizing in the following two years.

 While General Mills has pursued efforts to improve cost of goods productivity in recent years, Goldman Sachs said “the primary source of gross margin gains for the firm may be attributable to input cost relief.”

Mr. English said General Mills could prove Goldman’s projections too conservative if the company were to pursue more aggressive cost-cutting strategies.

While selling shares of General Mills may prove risky in a frothy merger and acquisition environment, Mr. English said the risk “cuts both ways.” He acknowledged that margin challenges facing General Mills may make the company an acquisition target for a buyer “willing to take bolder action to unlock inefficiencies.”

The flip side of this situation is what Mr. English called elevated risk that General Mills will pursue “relatively expensive ‘growthier’ companies to build its own growth outlook and rebalance the portfolio to better align with consumer trends.”

Because valuations in the food sector already are elevated, Goldman is ”wary of the value creation potential” of any large acquisition in the near term.

The possibility of such a move by General Mills is significant, Mr. English said. The company paid a 27 times EBITDA multiple in late 2014 for Annie’s.

“Management has cited reshaping its portfolio towards faster growth opportunities as a key priority and lists past merger and acquisition, as well as organic expansion, as examples of the steps it is taking to achieve this,” he said. “Its recent success growing Annie’s post acquisition may have emboldened its confidence on the m.&a. front, in our opinion. Given elevated m.&a. multiples for growth-oriented staples businesses, we expect any incremental deals to be dilutive to both earnings and returns in the near term, thereby serving as another potential downside catalyst.”

Mr. English said his projections come in an environment in which consumer packaged foods companies already are generously priced.

“Staples relative valuation is back to recent highs while General Mills’ price/earnings ratio also remains much above its five-year average,” he said.

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