General Mills: Squeezing Double-Digit Returns From The Stable Company (NYSE:GIS)


The coronavirus crisis is continuing to deepen, urging us to move our investments towards defensive sectors. The second wave of the virus is accelerating in the world, and another lockdown is probably inevitable. In the USA, daily new cases are surpassing April records, while South America is suffering heavily from the healthcare crisis. Europe is opening its borders for tourists from certain countries, which might cause the virus to spread in Europe again. Thus, we will analyze pandemic winner stock – General Mills (GIS) – to see how we can squeeze returns from the stock.

Data by YCharts

Though the company underperformed the S&P 500 (SPY) during the last decade, it was considerably outperforming the market averages during the March-May period of this year. The stock is positioned quite well, as it outperformed even the coronavirus winner Walmart (WMT) during the lockdown period.

General Mills

(Source: Food Business News)

Business

General Mills is benefiting considerably due to coronavirus crisis, as its at-home products represent about 85% of total revenues. The lockdown period contributed to the company’s sales, as in Q4 2020, organic growth was about 16%. The biggest driver of this growth was the North America Retail sector, which amounted to 59% of the company’s total sales and recorded 28% organic growth. The US Meals & Baking field recorded a whopping sales increase of 68%. At the same time, cereal demand increased 26% due to COVID-19-driven at-home food demand. So, the lockdowns created tremendous tailwinds for the company, and they can cause the top line to increase considerably.

General Mills Sales Segments

(Source: 10-K)

Even if lockdowns ease, the coronavirus cannot disappear that quickly, which means that lots of people will continue to stay at home voluntarily and lessen their restaurant visits. Many employers let their employees to work from home even after the mandatory lockdowns were eased, which can create another tailwind for General Mills. Thus, we can expect that the 2020-2021 period might be quite beneficial for the company, as it can eventually increase its growth rate, which was rather flat in the last 10-year period (1.4% revenue CAGR).

General Mills Revenue

(Source: Author’s Spreadsheet)

In the long run, General Mills cannot expect any dramatic changes in its revenues, as it is operating in mature industries with too high competition. The 2010-2018 period was too stagnant for the company, as the top line increased only at 0.9% CAGR. The company increased growth as it had entered a new field – the pet food industry. General Mills paid $8 billion for Blue Buffalo, which was experiencing double-digit growth after 2018. According to a study published by Allied Market Research, the industry would grow at 4.1% CAGR until 2022. The pet product sales are rapidly gaining share in the company’s total sales, as in FY 2020 the, industry represented 13% of total sales, while 2 years ago, it had only 8% share.

Dividends

General Mills has paid dividends in the last 120 years. Forward yield is 3.18%, which is considerably higher than the S&P 500 average yield of 2%. During the recent 20-year period, management was able to either increase the dividends or keep them stable. Even during the Great Recession, management continued to increase dividends. The only exception was in 2000, when the dividend decreased from $0.55 to $0.4125.

General Mills Dividends

(Source: Seeking Alpha)

The chart below indicates that the current dividend is quite safe. In FY 2020, the company paid only 32.5% of its operating cash flows in dividends and only 37.2% of its free cash flows (OCF minus CapEx).

General Mills Dividend Payout Ratios

(Source: Author’s Spreadsheet)

The real problem for dividends come from the debt burden, as in upcoming years, General Mills must service rather large amounts of debt. In the 2021-2022 period, the company must service $3.338 billion of debt. On an annual basis, it is about $1.667 billion of debt per year, which is about 73% of 2019 free cash flows and 51% of 2020 free cash flows. Nevertheless, the company might reissue a part of the debt burden in lower rates, as in recent months, the interest rates are declining rapidly due to huge quantitative easing programs.

General Mills Debt

(Source: 10-K)

Thus, we expect that the current dividend is safe, and company management will probably keep the dividends stable during these turbulent periods.

Challenges

General Mills generates 26% of its revenues outside the USA, which might become a headache for the investors. The coronavirus crisis might cause supply chain disruptions as countries might close their borders. Many products are produced in single locations, which further increases difficulties concerning supply chain operations during the crisis.

At the same time, the company might face uncertainties concerning exchange rate fluctuations. During the recessionary periods, the central banks are injecting horrendous amounts of “printed money” into circulation, which causes large fluctuations in the forex market. Now we witness new QE programs across the globe, which will probably cause unpredictable movements in the exchange rate market.

Valuation

Currently, the stock is trading lower compared to its 5-year median multiples. The P/E ratio is 15% less than the 5-year median, and the price-to-CFO ratio is 16% less than the 5-year median. The discount reflects the current uncertain market environment, as the coronavirus might cause lots of unpredicted headaches for the company. However, we don’t see here too much room for the stock to go higher, as market uncertainties will not disappear in upcoming quarters.

ChartData by YCharts

How to invest

General Mills is operating in a mature industry. The business is well-diversified and will probably continue to grow slowly. The coronavirus crisis might bring tailwinds for the company, which promises downside protection in the upcoming quarters. As a result, we will explore certain income-producing option strategies to benefit from the stock’s stability.

One of the simplest strategies – the covered call strategy – lets us possess the stock to enjoy the dividends and, at the same time, write a call option to also collect the premium. The January 15, 2021, call at $62.5 strike is trading at $3.4.

If you buy the stock at the current price and write the mentioned call, you will receive a 5.5% return from premium in just 5.5 months. On an annualized basis, the return is 12.39%. At the same time, investors might receive a 3.18% dividend, which will bring you a 15% return if the stock price remains flat or goes higher. Our price appreciation opportunity is capped at $62.5, which is 1.6% higher than the current price. The return is higher compared to the stock’s 5-year period annual appreciation of 7.3% and the average 3.5% of the dividend.

Another strategy, which we call cash-secured put, will let us sell a put to raise the premium. We will suggest selling January 15, 2021 put at a strike price of $60, which is trading at $4.3. If the stock goes higher, then you will get an opportunity to collect a 7.1% return from premium (16% annualized). If it goes down, then you will receive an opportunity to buy the stock at $55.7 ($60 strike minus $4.3 premium), which is 9.3% lower than the current price. This is a very beneficial approach, as the two outcomes are more beneficial than simply buying the stock.

Another great strategy also nicely fits the current situation. Selling both call and put options expiring at January 15, 2021 at a strike price of $60 gives us a premium of $9.1. At the same time, we can buy the stock at the current price. The strategy gives us a 14.8% premium for the 5.5 months (35.8% annualized) and gives an opportunity to collect dividends. If the price stays flat or goes higher, our return will constitute 32.5% on an annualized basis (29% net premium plus dividend yield). If the stock goes one standard deviation lower to $49.5, then our loss will be only about $12.9.

Conclusion

Our analysis indicates that the company is safely positioned in its industry, its dividends are quite safe, and we do not anticipate any dramatic dividend cuts in the upcoming years. We see great downside protection and little room for the stock to go higher. Thus, I have suggested certain option strategies that can generate double-digit returns from the current stock condition.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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