General Mills needs an increase in volume. Waiting for a better entry point (NYSE:GIS)

General Mills (New York Stock Exchange: GIS) has an impressive collection of brands and holds or wins market share in many product lines. The company could grow at a high-single-digit pace, but is currently valued as a growth stock.of The Consumer Staples sector is represented by the Vanguard Consumer Staples ETF (VDC) fell just 4%, while the Vanguard S&P 500 ETF (Boo) fell 11.4%. But this run may have run out of steam. General Mills may report some more good quarterly growth, but the growth may not be sustainable over the long term. Investors may be better off waiting for the stock price to rebound.

Unsustainable price increases hurt sales volumes

The company has had uneven revenue growth over the years, with an average annual growth rate of A rate of 0.83%. The company’s revenue growth has been relatively uneven, with a high standard deviation of 4.8% for him. Since May 2020, the company has averaged 2.4% y/y quarterly revenue growth. (Appendix 1)However, revenue growth in Q2 2023 was driven by price increases of 17%, while volumes declined 6%, leading to 11% organic growth. (Appendix 2)Total net sales in the second quarter of 2023 increased 4% year-over-year. A company sale reduced revenue by 5%, and a stronger dollar reduced revenue by 1%.

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The company envisioned a similar situation in the first quarter of 2023, with a 15% price increase boosting sales while volumes fell by 5%. The company has experienced inelastic demand in the face of double-digit price increases. However, that pricing power may not last long, and at some point consumers will be shocked and refrain from spending.

Overestimation based on metrics and DCF

General Mills is valued as a growth stock but overvalued based on valuation metrics and a discounted cash flow model. Equity trailing GAAP PE is 17x and forward PE is 18x, with a five-year average of 16.5x. The company sells at a futures price of 2.4x compared to a five-year average of 1.98x.

A discounted cash flow model that assumes a long-term growth rate of 5%, a free cash flow margin of 12%, and a discount rate of 10% results in an equity value of $62.05 per share. (Appendix 3)The company is currently trading at $77.46 and is 24% overvalued. Given that the company’s average annual growth rate is less than his 0.8%, a 5% earnings growth rate may be too optimistic.The company averaged annual free cash flow [Operating Cash Flow – CapEx] The margin is 12.5% ​​and the standard deviation is 2.3%. Therefore, we can assume that a long-term free cash flow margin of 12% is appropriate for the company.

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Watch for rising inventory levels for signs of slowing sales

Investors should watch the company’s rising inventory levels closely. Over the past 10 years, General Mills has sold an average of 52 days of inventory with a standard deviation of 4. (Appendix 4)One standard deviation from the average is 48 to 56 days worth of sales of inventory. As of the last 12 months of data, the company’s inventory is his 59-day supply, well over one standard deviation from the average. The company’s volume decline has been subdued in the face of double-digit price increases, but that may not last if inflation persists and the company implements further price increases. A faster decline in volume could lead to further spikes in inventory levels, lower sales, and lower profit margins.

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Inventory costs are soaring for consumer goods and manufacturing companies (Appendix 5) the past year. Some, such as RPM International (RPM), are now forecasting lower sales heralded by a surge in inventory levels. McCormick (MKC), which reports quarterly results on Jan. 26, may be in trouble due to high inventory levels of 125 days versus average 101 days of sales.

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Dividends, Debts and Buybacks

General Mills has increased its dividend by 2.9% over the past year, compared with an average growth rate of 1.3% over the past five years. The company pays his 2.6% dividend, which is a good yield compared to the 1.6% yield of the Vanguard S&P 500 Index ETF, but lower than his 4.2% yield on his risk-free 2-year Treasury. am. The payout percentage is 50% which is easy to handle.

GIS has a relatively high debt of $11.7 billion and a current debt-to-EBITDA ratio of just over 3x. The company has low short-term liquidity as measured by quick ratio and quick ratio. Operating cash flow for the 12 months was $3.01 billion, reaching a debt to operating cash flow ratio of 3.8x. The company has focused on buying back shares at the expense of paying down debt.

Between 2013 and 2022, the company repurchased $7.9 billion of its stock and issued $2.6 billion worth of new shares. It continues to buy back its own shares while refinancing its debt. GIS has more financial and strategic flexibility when its debt-to-EBITDA ratio doubles or less.

price momentum

Stocks are up 13.1%, but the Vanguard S&P 500 Index ETF is down 11.4% over the past year. Stocks have lower volatility than the market, with a beta of 0.33.However, RSI and MFI technical indicators for stocks are approaching oversold levels (Appendix 6)The market turmoil has prompted investors to take refuge in the consumer staples sector, which is densely populated with low-beta stocks and expanding valuation multiples.

Since early 2023, however, investors have returned to high-beta technology stocks, with the Invesco QQQ ETF (QQQ) (NASDAQ-100 company) returning 6.8% year-to-date. The rise on the Nasdaq may have spurred a sell-off in consumer goods stocks as General Mills fell 6.9% year-to-date. Consumer stocks could be hit hard if the Nasdaq continues to rise. This selling could turn into a buying opportunity if valuations drop further.

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General Mills has outperformed the market over the past year, but price momentum has weakened. Stocks are overvalued based on valuation metrics and discounted cash flow models. The company is heavily indebted, but needs to grow its dividend faster to keep up with the yield offered by the two-year US Treasury. General Mills has great brands and good inventory to hold for the long term, but there are good times to buy stock.