General Mills Investment in Blue Buffalo Continues to Pay Off

General Mills (NYSE:GIS) reported earnings for their second quarter of 2020 on December 18. The company beat earnings expectations by 7 cents per share for an upside surprise of 8.4%. The earnings were also a pleasant 10 cent per share year-over-year increase. Net earnings for the quarter were up 69% to $580.8 million. Adjusted gross margins were also higher, rising 80 basis points to 35.3%.

General Mills is taking a very disciplined approach to improve its product mix to align with consumer tastes. In addition to its acquisition of Blue Buffalo, the company also purchased organic food maker Annie’s and Yoki Alimentos, a Brazilian food company. This is not necessarily the behavior investors would expect from a company that is one of the bluest of the blue-chip stocks.

However, General Mills stock gains are being held back a little bit as the company missed on revenue. GIS posted revenue of $4.42 billion in the second quarter which was slightly lower than analysts’ expectations of $4.43 billion. This has been a source of concern for some investors who view the company’s revenue losses as a sign that consumers are turning away from the company’s core packaged goods.

However, on that front, the company did report an overall gain in organic sales of 1% in the second quarter as well as a 5% gain in cereal sales. The company also projects organic growth to continue to rise by 1%-2% for the remainder of its fiscal year.

Speaking on the conference call, CEO Jeff Harmening said that the company plans to increase its marketing spend to maintain its sales momentum. “Our goal is to accelerate sales growth again, and we’ll do that by marketing and product innovation,” said Harmening.

One example of how the company plans to execute this strategy is in the cereal category. In the second quarter, the company focused on advertising its largest brands and also introduced new products to entice consumers.

Teaching an old dog new tricks

The venerable company surprised some investors last year by acquiring the Blue Buffalo Pet Products last year for $8 billion. At the time, General Mills was responding to the megatrend towards consumers showing a willingness to purchase high-end ingredients for their pets.

According to The American Pet Products Association, U.S. pet food sales exceeded $72.56 billion in 2018 and are expected to increase by 3.8% this year and again in 2020.

In fact, the pet food category is one of the fastest-growing sub-sectors of the consumer staples sector, with industry sales rising 10% in recent years. At the time of the acquisition, Blue Buffalo had seen its sales grow at an annualized rate of 12% for the previous three years.

If the current earnings report means anything, it seems that investment is paying off richly for General Mills. Largely due to the launch of Blue Buffalo in Walmart (NYSE:WMT) stores, as well as other price increases, the pet division of General Mills was the primary reason for the stellar earnings report. Sales in this division rose 16% in the quarter. This was after a 7% increase in revenue from their pet division in the first quarter.

More importantly, the company’s decision to increase Blue Buffalo’s retail exposure appears to be helping it stave off the threat from Amazon (NASDAQ:AMZN). The e-commerce giant is also making a move into the premium pet food category of which it already controls approximately 55% of the premium pet food market.

Investors still have some concerns post-earnings

Although the increase in revenue in their pet division cannot be overlooked, it represented just 10% of the company’s overall quarterly revenue. This has some investors concerned about the strength of the company’s core businesses and the need to get those businesses on track. And the company’s earnings report still showed a weakness in both yogurt and packaged snack bar sales.

With the lift from the earnings report, GIS stock is up over 42% in the last 12 months. This is well ahead of the S&P 500 Packaged Foods & Meat Index which is reporting just a 17.5% gain for the same period. Still, the stock currently has a consensus “Hold” rating from a panel of 19 Wall Street analysts who cover the stock.

The company also has a healthy dividend. However, in a nod to their acquisition of Blue Buffalo, the company broke its 13-year streak of increasing its dividend. However, the company still maintains a 15-year streak of dividend growth. The dividend yield is still a robust 3.71%.