from a high level General Mills‘ (GIS 0.62%) The performance in the second quarter of 2023 looked very strong. But dig a little deeper and you’ll find that the company’s pet food business was notable, and not in a good way. given that it is important for investors to understand what is going on. Here’s a quick rundown of what you should monitor.
it was a good quarter
Food manufacturer General Mills posted a 4% sales increase in the quarter and a strong organic sales increase of 11%. Earnings per share increased by 12% year-over-year. It would be very difficult for investors to complain about these numbers. This was driven by higher prices (more than offsetting lower volumes) and improved margins.
The key takeaway for the quarter was that inflation significantly overturned the consumer staples space, but General Mills seems to be handling the blow fairly well. However, not all business units were operating at their best. Notably, the company’s pet food business, which consists primarily of the Blue Buffalo brand, saw flat organic sales and a steep 34% decline in segment operating profit.
This is an important business for General Mills, which acquired Blue Buffalo in 2018, and we expect it to drive growth over the next few years. So far, the story has been pretty good. From fiscal 2018 to his fiscal 2022, the Blue Buffalo business grew sales at his 15% compound annual rate. This is very attractive, basically justifies an acquisition that some thought was expensive, and shows that General Mills knows how to be successful in pet food.
If Blue Buffalo is doing well, why did it perform poorly in the second quarter? There are some issues, but they may all be temporary.
First, some of General Mills’ customers chose to reduce the inventory they held. This is not surprising given the extraordinary shift in inventory levels caused by the pandemic. Add to that concern that the economy will weaken in 2023, and there’s even more reason for retailers to cut back a bit. Fortunately, inventory reductions usually last only a short period of time before sales begin to return to more normal levels.
Meanwhile, the company seeks to build loyalty for the Blue Buffalo brand through advertising and other means that help move the product in the consumer space. As a result, retailers may find it more necessary to start buying again.
The second problem facing General Mills is called service levels. Basically, logistical issues make it difficult to put products on the shelves. This is another short-term headwind that is likely to dissipate over time. Management is adding logistical capacity to address this issue.
The last problem is likely the most difficult to overcome. Blue Buffalo continues to fall short of production targets. A long-term solution is the building of new production capacity that General Mills is doing. However, this does not solve the short-term problem of insufficient capacity. Therefore, management employs contract manufacturers to enable a rapid start in production, primarily for dry food and pet treats.
A disadvantage of using a contract manufacturer is that it is generally more costly than producing the product in-house. So the operating profit may look a little weaker, noting that the company is also making capital expenditures to build internal capabilities. The benefits easily outweigh the initial cost. Overall, fixing capacity constraints may take time, but it seems likely that they too will be addressed in time.
benefit of the doubt
Given General Mills’ past success with the Blue Buffalo brand, investors probably shouldn’t be too upset by the weak quarter. Or even some weak quarters, as long as the steps being taken to address the problem appear logical. Investors should keep an eye on the pet food business, but the problems it faces are no reason to jump right in.