General Mills caused grumbles on Wall Street last week with another downward revision to its forecast for a key profit metric – the second change announced in a month. The US group “feels good” about its top-line performance but knows it needs to work on its profitability, even if it insists some of the factors affecting its bottom line are sector-wide. How General Mills reacts will be keenly watched by investors and industry. Dean Best reports.

Transport and commodity costs hit profits

Announcing its third-quarter results on Wednesday (21 March), General Mills now expects its annual “total segment operating profit” to fall by 5-6% on a constant-currency basis, compared to an earlier forecast issued – and itself downgraded – just last month at the CAGNY investment conference – of flat to down 1%.

This second revision in a month hit General Mills’ shares, which fell 9%, the largest one-day slide for nine years.

The company pointed to “higher-than-expected supply chain costs, including freight and logistics, commodities, and other operational costs”. 

Like other US food companies, General Mills has been facing rising transport costs amid a shortage of drivers and higher fuel prices in the country. “North American freight spot prices were near 20-year highs in February,” chairman and CEO Jeff Harmening said on Wednesday.

The General Mills chief said the Cheerios maker had seen prices for “some key commodities, including grains, fruits and nuts” rise, while pointing to a further impact on costs from the company’s improving sales, with “operational costs driven by higher volumes running through our network” and increased expenses from “intra-network shipments … as we move more products to the right locations to satisfy the strong demand”.

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Harmening said the pressure from rising prices of some raw materials could be put down to the volatility in commodity costs that “ebbs and flows over time” but his comments on freight costs would have been closely watched. “I think our logistics costs are structural; I don’t think that they are going to go down,” Harmening told analysts. 

General Mills’ attention to costs called into question

Given General Mills had made its second change to a key profit forecast in a month, it was understandable Wall Street analysts on the company’s conference call to discuss the results pushed the business on how it monitors its costs.

Reflecting on General Mills’ appearance at the CAGNY investment conference last month, Robert Moskow, senior food equity analyst at Credit Suisse, said: “You did lower guidance for higher freight costs at that time, so you must have had some kind of a roll-up of how much spot activity was going on during the quarter. What was wrong with the data?”

CFO Don Mulligan acknowledged General Mills, looking back, would have done things differently.

“Obviously, when we gave our guidance at CAGNY that was based on the best information we had at that time. I mention the fact that we do periodic costs deep dive, we did one in February, at the end of February and we did it as we closed the books on the quarter in early March, and that is when these cost really came to the fore more clearly, and that’s what’s prompting the guidance change today. We have done these at regular intervals.

“Clearly in today’s environment we have to do them more regularly and be more agile in terms of identifying the cost trends and make sure they are surfaced and acted upon and we will do that.”

Harmening added: “We understand the ramifications of changing current year outlook in such a short period of time, and we are taking steps to ensure this doesn’t happen again.”

Management pleased with progress on sales

General Mills’ 2013/14 financial year was the last year in which it saw some growth in its net sales on organic basis.

In the company’s 2016/15 fiscal year, sales by this metric dropped 4% – a performance that followed two flat years.

At CAGNY last month, General Mills tweaked its forecast for its organic sales in its current financial year, saying it expected this fiscal period to be a year of organic sales being in line with the previous 12 months – but noting it had previously forecast the metric could be “flat to down 1%”.

Announcing its third-quarter results on Wednesday, General Mills did maintain this forecast from CAGNY and pointed to a 1% increase in its sales on an organic basis during the three months to 25 February.

Harmening said General Mills had seen “the fourth consecutive quarter of sales improvement” in its core US retail business.

“Our improvement is driven by solid fundamentals. Our baseline sales trends are 500 basis points better than last year and are driving 75% of our retail sales improvement,” he added.

Yoplait owner sees US yogurt sales fall – but touts improvement

General Mills’ US yogurt business has been something of a problem for a number of quarters, faced with intense competition in a market that was once buoyant but actually saw sales fall last year.

In the Yoplait owner’s third quarter, General Mills again saw its own sales slide but Harmening said the decline actually marked another period of improvement.

“US yogurt net sales were down 8%, which represents the third consecutive quarter of improvement as our portfolio benefits from successful innovation and faster growing year-over-year segments,” he said.

“We’ve improved our retail sales trends by 16 points this year by innovating into faster growing spaces. Our retail sales were down just 3% in February and we actually grew a market share in the grocery channel last month.”

Rightly, Harmening did concede the numbers still left the company wanting more. “We’re pleased with our US yogurt improvement but we’re not yet fully satisfied. We continue to improve by building on recent successes and by launching new category expanding innovation. We have another important launch planned for this summer that addresses some of the biggest health and wellness fares in the yogurt category.”

General Mills faces questions on pricing

Nevertheless, despite the signs of progress General Mills is making more broadly on its top line, the company still faced questions about whether, amid the pressure it is facing on costs, it can succeed in pushing through price increases.

On the call, Jefferies analyst Akshay Jagdale put to General Mills’ management some of the questions being put to him by the market.

“In the months to come and the quarters to come, you’ll have to show that your brand is strong enough to pass that on; that will have to play itself out. What I’m more concerned about and the questions we get is you’re having this really nice performance and improvement on the sales side – but how much visibility do you have on the incremental profitability from these new products and the sales growth that you’re seeing?” Jagdale asked.

Focusing his reply on the record of General Mills’ recent innovation, Mulligan said: “We obviously look at all of our new products in terms of their incrementality both from the top and the bottom line. [Yogurt brand] Oui is a great example where we’re generating more out of per cup basis on our base product even though the margin percentage themselves are not materially different but you have a higher price point. What we’re seeing this year is our new product volume is performing very well.”

Harmening took a broader view and reiterated General Mills’ satisfaction about the improvement it is seeing in sales.

“I couldn’t be more pleased with the way that we have been able to pivot and grow our top line,” he said. “I just want to unequivaocably say I love the way they were executing, our sales and our marketing teams are executing well together, our marketing campaigns are better, our new products are together. I’m displeased with our profit performance in the third quarter and the fact that we didn’t see some of this coming as much as we should have but I am really pleased with what the organisation has done about returning to growth.”

As well as working on controlling costs, the Yoplait owner said it would look to improve its profitability by raising prices in certain areas.

Harmening, pointing to data he showed General Mills’ recent ability to increase its prices, said the company would be “maintaining a disciplined approach to our pricing”.

“Our baseline and merchandise price points have been higher than last year throughout fiscal ’18 including the third quarter. When you look over a two-year period, our average prices across our portfolio were up 4% and are outpacing our aggregate categories,” he explained.

The General Mills boss then argued the company’s customers are facing the same kinds of pressure on costs as the manufacturer is seeing.

“What we see on the logistics side is very real and our customers face it all the time,” Harmening said. “We feel like we can [see some net price realisation] because everyone is feeling it in the industry, our competitors are feeling it, we’re feeling it, our customers are feeling it.”

General Mills’ management sought to be precise on how the company would look to achieve some of that “net price realisation”, to use the industry jargon.

“We’re also taking smart actions to drive positive net price realisation in a higher cost environment by pulling various levers within our strategic revenue management tool box,” Harmening said.

General Mills’ competition will be on the look-out for moves from the Annie’s owner on price, pack and promos in the days and weeks ahead.

“We can realise prices in a variety of ways – and that includes trade optimisation and price pack architecture in addition to some more of the traditional pricing,” Harmening explained.

He added: “Our categories are already seeing 1% to 2% pricing consistently quarter-to-quarter; just a little bit of pricing combined with these cost measures will really help alleviate the pressure on our input cost.”