Falling Sales Plague General Mills

Management was forthright that these results fell short of its initial expectations (but aligned with our outlook for a mid-single-digit sales shortfall) and that a heightened focus on brand investments is necessary. And while we agree with the sentiment, actions speak louder than words, and this rhetoric isn’t new. As we’ve articulated, we portend a pullback in brand spending has artificially inflated profit levels across the industry, which we’ve argued are unsustainable. In our view, firms throughout the space need to bolster brand spending (which we estimate slumped nearly 20% at General Mills in fiscal 2017) to withstand competitive pressure and ultimately ensure that its brand intangible assets persist longer term. As a result, we forecast marketing spend to exceed 5% of sales the next 10 years, almost 100 basis points north of its average the past three years.

While we intend to review the assumptions underlying our discounted cash flow model and will likely bump up our $58 fair value estimate modestly to account for our expectation for corporate tax reform in the U.S. in calendar 2018, we don’t foresee a material change to our long-term outlook (for low-single-digit annual sales growth and operating margins around 20%, about 400 basis points above the five-year average). Share ticked up at a low-single-digit rate following the results but continues to trade in line with our valuation. We don’t view the risk/reward opportunity in this narrow-moat stock as favorable.

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