General Mills disappointed the market this week (20 December) when the US group lowered its full-year revenue outlook on the back of a 7.1% drop in sales during its second quarter. The company’s aggressive cost-cutting programmes enabled it to maintain its margin guidance but, Katy Askew asks, is the group’s weak top line evidence management has cut spending in certain areas too deeply?

On Tuesday (20 December), General Mills said it saw its sales slip by over 7% during the second quarter, dropping to US$4.11bn in the three months to 27 November. On an organic basis, sales were down by 4%, while the disposal of Green Giant last autumn trimmed a further 3% off the top line. 

The decrease, led by General Mills’ US retail business, a division that accounts for around two-thirds of the Old El Paso maker’s total sales, prompted the company to reduce its forecast for full-year sales. The owner of brands from Cheerios cereal to Yoplait yogurt said it now expects its annual net sales to fall 3-4% on an organic basis, compared to its previous forecast of flat to down 2%. 

General Mills, whose stable of brands also includes Progresso soup, said its constant-currency total segment operating profit is now expected to rise by 2-4% over the full year, lower than its previous estimate of growth of 6-8%.

Nevertheless, Pablo Zuanic, an analyst at at US investment and trading firm Susquehanna International Group, describes the guidance as “not as bad as we feared”. He elaborates: “We had expected cuts to sales growth, to the margin target, and to EPS, but only sales growth guidance was cut.”

Despite lowering its operating profit target, General Mills maintained its goal of a 150 basis point gain in EBIT margins, excluding items skewing comparability, for fiscal 2017. 

A sharp focus on margin expansion has marked General Mills’ approach to delivering investor returns in what has become a low-growth packaged foods environment in its major markets across North America and Europe. 

Speaking during a conference call, president and COO Jeff Harmening explained: “There are different levers we can pull to drive shareholder return. Sales growth is clearly the one that has the longest term benefit and where our focus is, but there’s clearly margin expansion, there’s cash conversion, and cash returned to shareholders. At different points in our history, we’ve pulled those at different strengths based on what the market can bear and, as we looked at the market over the past couple years and at least for the near term, with less available top-line growth, we wanted to make sure that we were still delivering a competitive return for our shareholders and that meant more on the margin.”

General Mills’ margin efforts include its holistic margin management programme, which focuses on reducing the cost of goods sold. The company said the programme has delivered savings of $1.2bn between 2015 and 2017 and it is targeting $4bn in savings by the turn of the decade. 

Additionally, General Mills has also streamlined its global production base and 11 facilities will have been closed between 2014 and 2018 as the group works to take excess capacity out of its network. Administrative expenses have been targeted through the implementation of a zero-based budgeting initiative. Most recently, the company announced plans to reorganise its global business into regional units that will report directly into Harmening.   

As part of that change, CFO Doug Mulligan explained General Mills anticipates eliminating 400-600 positions worldwide, driving estimated savings of $70-90m by 2018. In total, the group will have reduced its global headcount by 5,000 people by 2018. Taken as a whole, General Mills said the programme will deliver $700m in savings by 2018, on top of the cuts from the holistic margin management initiative.

“We’re progressing well on our goal to 20% adjusted operating profit margins by fiscal ’18, which represents more than 300 basis point improvement over fiscal ’16 levels,” Mulligan insisted. 

As well as reducing its cost base, General Mills has slashed its controllable costs to inflate quarterly profits. The company has, for example, cut its marketing spend by 20% year-on-year in both the first and second quarters. 

“Selling, general, and administrative expenses decreased $65m to $708m in the second quarter of fiscal 2017 compared to the same period in fiscal 2016. The decrease in SG&A expenses primarily reflects a 20 percentage point decrease in media and advertising expense,” General Mills revealed in its 10-Q filing. 

The rationale behind cutting its consumer-facing spend may go beyond the desire to lift quarterly profits in a challenging period. Management aimed to refocus its spending behind brands that were generating the best returns, maximising its investment. However, the top-line decline tells a different story. 

As CEO Ken Powell conceded: “Our net sales performance did not meet our expectations in the second quarter. We didn’t have enough marketing support – meaning the combination of trade, media and new product news to drive improved top-line results – and on top of that we saw a slowdown in food industry growth in the US in recent periods.”

Without brand support, General Mills left its blockbuster brands at risk of market share erosion from smaller entrepreneurial companies that have acted as disruptors in the US food sector. General Mills also saw increased competitive pressures from its peers such as Kellogg in cereal and Campbell Soup Co. in soup, who increased activity behind their legacy brands. 

“The operating environment… is rational, but in some of our biggest categories, we did see an increase in trade promotion in the second quarter. We saw it a little bit in soup, where our lead competitor had a pretty poor fall last year and came back a little stronger. Then we saw it a little bit in cereal as well and also in refrigerated dough. So for three of those categories, we saw some more promotional support than we had – than we had seen before – and that really in combination with our pulling back was part of the challenge we saw in the quarter,” Harmening noted. 

In the US, cereal, baking products, yogurts and meals revenue dropped by 3%, 7%, 17% and 17% in the second quarter respectively. These decreases offset a 1% rise in snack sales to drive a 9% drop in total sales in the market. 

General Mills may have lowered its marketing investment but the company has continued to invest in product development in an attempt to keep up with rapidly evolving US consumer preferences. For example, during the first half, General Mills launched it’s Annie’s and Lärabar brands into the yogurt sector and renovated its Gogurt offering. 

The group also has a pipeline of NPD for the remainder of the year. It is rolling out new Fibre 1 layered bars containing grains and caramel with almond and chocolate toppings. General Mills has renovated its Greek 100 protein line and will be rolling out a new cereal variety, Cheerios Very Berry. 

However, Morningstar analyst Erin Lash notes, bringing new products to market without appropriate support is not enough to ensure a successful launch. 

“We think the onus is on packaged-food manufacturers like General Mills to ensure that new products consistently resonate with consumers. But just bringing on-trend products to market is insufficient to winning in this marketplace, as even value-added new products can fail if consumers don’t know about them. In this light, we believe that maintaining – or even increasing – its brand spending will be crucial to beef up brand awareness,” she told just-food. 

While General Mills management acknowledged a slash-and-burn approach was not beneficial for all its brands, on the other hand, it also insisted there are examples where reducing brand spending has actually paid dividends. 

“Importantly in some areas, we reduced our spending on trade, for example on Old El Paso and Totino’s hot snacks, and we got it really right and we increased our revenues partially as a result of that, along with some good innovation,” Harmening stressed. 

“We think it’s very clear that taking a very disciplined approach to spending, both trade promotion and consumer, is the right thing to do… We just don’t want to promote in ways that create a loss for us. The same of course is true for consumer spending – we’ve got to see the return. I think we remain very convinced and committed to expecting strong return from our promotional and advertising dollars.”

General Mills is balancing the need to drive sales growth against the need to ensure that this growth is also profitable. It remains to be seen whether the company will get it right in the remaining six months of the year.

Is zero-based budgeting right for everyone? – just-food analysis from October 2016