General Mills: Is The King Of Comfort Food Fully Valued?

I recently advised caution on the market while also recommending General Mills (GIS) as a good defensive name in a down market. With brands like Cheerios, Betty Crocker, Pillsbury, Haagen-Dazs and Yoplait, its foods are available on grocery shelves from Miami to Anchorage with a nice dose of international exposure accounting for 20% of revenue.

Forget guns and gold. There’s no more sensible reaction to financial Armageddon than hunkering down inside to gnaw on a tube of cookie dough and scrape the bottom of a pint of Pralines and Cream. In fact, this pick fits well with the burgers, beer and butts strategy I advocated some time ago. So without further ado, here are the fundamentals.

Profitability

Earnings per share have averaged growth of 13.3% annually for the last three ears. They have risen steadily over the last decade and were not materially affected by the Great Recession. Margins have also remained strong in the face of higher input costs with net margins actually rising to 12% in 2011. With operations that began before the television and automobile, General Mills is an extremely profitable operation built on a solid cache of enduring brands.

General Mills' Earnings Per Share:

2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
.67	1.22	.1.38	1.54	1.45	1.59	1.86	1.90	2.24	2.70

Debt

Great businesses typically generate strong cash flows and require little debt financing. I like to see long-term debt less than three times current net earnings. With long-term debt of $5.5 billion and trailing 12-month net income of $1.6 billion, General Mills narrowly misses the mark here. However its strong free cash flow keeps me from being overly concerned.

Return on Equity

Companies that consistently deliver high returns on equity create true wealth for shareholders. Average businesses typically offer a 12% return on equity while great businesses return over 15%.

General Mills Return on Equity (rounded):

2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
25	24	22	23	19	21	22	23	29	31

General Mills' 10-year average ROE is a stellar 24%.

The Dividend

This Dividend Challenger (see David Fish's invaluable list of dividend growth names) currently offers a 3% yield supported by a 52% payout ratio. It has increased its dividend for eight years in a row at an average 11.1% clip over the last five years.

Retained Earnings

I want to own companies that are free to reinvest retained earnings at high rates of return. What I don’t want to see is high research and development costs or capital expenditures in the form of plant and equipment replacement. A look at General Mills' balance sheet reveals that it regularly spends about one third of net income on property, plant and equipment but has no R&D costs. SG&A costs have been rising and should be monitored for margin drag.

Valuation

At $40.79, General Mills sells for a P/E of 17.3, which is a hair higher than its historical average of 16.1. Based on projected growth of 8% annually, its forward PEG ratio is high at 2.1. The valuation is more compelling if we use the current P/E and three-year average growth rate giving us a PEG of 1.3. Strong volume on September 22 leads me to believe that any pullbacks will be well-supported at the $40 level. However I would prefer to wait for a more attractive price before initiating a position since expected returns from current levels are only in the mid single digits.

In the next few weeks, I'll be covering a number of names in the food processing sector. Here's a preview of the players:

General Mills (GIS)								Hormel (HRL)
		Winner				Winner
Kellogg (K)								Campbells Soup (CPB)
				Champion
Heinz (HNZ)								Kraft (KFT)
		Winner				Winner
JM Smucker (SJM)								Nestle (NSGRY.PK)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.