General Mills Inc
NYSE:GIS
Earnings Call Analysis
Q2-2024 Analysis
General Mills Inc
The company is heading into the next half of the year with robust innovation across its billion-dollar businesses, particularly in cereal, yogurt, soup, Old El Paso, and Haagen-Dazs. Notably, the quality of merchandising has improved, providing better returns on marketing investments despite an increase in the frequency of promotions. This uptick in promotional activities is still below pre-pandemic levels in both frequency and depth, suggesting a controlled approach to driving sales without compromising margins. The effective merchandising and the stable promotional environment are expected to contribute positively to future revenue growth.
The company has repurchased more shares than anticipated earlier in the year, signaling strong financial discipline and commitment to shareholder value. This approach also reinforces the company's solid net debt-to-EBITDA levels, which provides them with the flexibility for strategic acquisitions if opportunities arise that align with business goals. In summary, the increased share repurchasing reflects the company's confidence in its financial strategy and ability to balance returning capital to shareholders while remaining open to growth through mergers and acquisitions.
Despite an $800 million reduction in sales expectations at the midpoint, the company has restrained its earnings before interest and taxes (EBIT) growth guidance revision to a minor extent. The company attributes this to Holistic Margin Management (HMM) savings, which are on track to achieve 5%, surpassing prior expectations of 4%. Additionally, relatively stable inflation and supply chain cost reductions have helped offset revenue pressures. Furthermore, adjustments to incentive compensation based on revised projections have led to almost $100 million in reduced administrative expenses, bolstering the company's ability to maintain profitability guidance within the expected range.
The company's gross margins have recovered to pre-pandemic levels, thanks in part to HMM contributions, but it is also focused on mitigating supply chain disruption costs. Moving forward, gross margin expansion is likely to normalize around historic levels of 4%, assuming the supply chain environment remains favorable. This suggests that while the company anticipates some level of future gross margin improvement, it remains cautious about potential volume deleverage and its impact on profitability.
As the company begins to compete on an even footing with competitors' shelf availability, share performance is expected to improve. By maintaining strong brand support, enhancing product innovation, and ensuring effective in-store execution, the company is poised for continued share growth in 60% of its North American Retail categories. Additionally, while dollar market share has been a challenge, the company reports growth in pound share across 40% of its categories, thanks to its agile response to inflationary pressures.
The company's executives acknowledge ongoing inflation as a factor influencing strategic price and promotional considerations. The expected category growth rate benefits from a lapping of Snap emergency allotments and previous pricing activities. While consumer economic pressures remain a variable, the company is observing improved but still adjusting consumer behaviors in the midst of a new economic reality. In terms of promotions, the quality and return on investment have improved year over year, suggesting that the company is navigating the current economic environment effectively in its marketing strategies.
Despite inflationary headwinds, the company remains committed to pricing strategies that support long-term shareholder value creation and meet consumer needs. The leadership highlights an inflationary environment, particularly within the low single digits, guiding future pricing decisions. The strategic approach appears to be balanced, with a focus on maintaining brand strength and market availability rather than aggressive promotional activity, even as they continue to manage competitive shelf availability and consumer price sensitivities.
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Good morning. This is Jeff Siemon, Vice President of Investor Relations and Treasurer. Thank you for listening to General Mills prepared remarks for our fiscal 2024 second quarter earnings. Later this morning, we will hold a separate live question-and-answer session on today's results, which you can hear via webcast on our Investor Relations website. Joining me for this morning's presentation are Jeff Harmening, our Chairman and CEO; and Kofi Bruce, our CFO. Before I hand things over to Jeff, let me first touch on a few items. On our website, you will find our press release that posted this morning, along with a copy of the presentation and transcript of these remarks. Please note that today's remarks include forward-looking statements based on management's current views and assumptions. The second slide in today's presentation lists several factors that could cause our future results to be different than our current estimates. And with that, I'll turn it over to Jeff.
Thank you, Jeff and good morning, everyone. Let me start by summarizing today's key messages. While we saw a slower-than-expected volume recovery in the second quarter, we generated growth in the bottom line, thanks largely to our strong performance, generating holistic margin management cost savings. As the operating environment evolves, we are adapting our plans to compete effectively and in a demand outlook that is more challenging than we initially expected. And we are remaining focused on driving long-term growth by investing in compelling brand-building ideas, increasing our pressure behind innovation and delivering strong in-store execution. For the full year, we revised our top line outlook to account for a slower volume recovery, narrowed our profit and EPS expectations but kept them within our original guidance ranges, thanks to accelerated HMM cost savings and maintain our outlook for strong free cash flow conversion.
Slide 5 summarizes our second quarter and first half results. Organic net sales were down 2% in the second quarter, reflecting a lower pound volume and a tough comparison to double-digit growth a year ago. Our 2-year compound growth rate on organic net sales was up 4% in the quarter. Q2 adjusted operating profit increased 13% and adjusted diluted earnings per share were up 14% each in constant currency. Our first half results included growth in the top and bottom lines with organic net sales up 1%, constant currency adjusted operating profit up 7% and constant currency adjusted diluted EPS up 6%.
As we exit the first half of fiscal 2024, the operating environment remains highly dynamic with ongoing changes upstream in our supply chain and downstream with our customers and consumers. While many factors have evolved in line with our expectations, including moderating levels of input cost inflation and price/mix, as well as a return towards historical price elasticities. We are seeing consumers continue to display stronger-than-anticipated value-seeking behaviors across our key markets. And this dynamic is delaying volume recovery in our categories. In addition, global supply chains have stabilized and service has improved more quickly than we initially anticipated. This has created both headwinds and tailwinds for our business. On the negative side, we have seen our competition make significant strides in improving their on-shelf availability, an area where General Mills was already performing well. And this has put more pressure on our market share performance in the short term.
On the other hand, a stabilizing supply chain has been a benefit to our efficiency, allowing us to step up our HMM cost savings and reduce disruption related supply chain costs. As a result of these changes, we've updated our fiscal 2024 guidance to reflect lower volume and organic net sales growth and improved HMM cost savings, enabling us to maintain profit and EPS guidance within our initial ranges. Kofi will share more details on our updated guidance later in today's presentation. Amid this dynamic operating environment, we remain focused on executing our Accelerate strategy and our three fiscal 2024 priorities, which are: to compete effectively by leveraging remarkable brand building, innovation and advantaged capabilities to win with a change in consumer. To improve our supply chain efficiency with a focus on increasing holistic margin management cost savings and reducing costs related to supply chain disruptions. And to maintain our disciplined approach to capital allocation by investing in the business, delivering strong cash return to shareholders and maintaining our balance sheet flexibility for portfolio reshaping.
Year-to-date, we made meaningful progress on priorities two and three, with more work to be done on priority one, competing effectively. We expect some of the recent headwinds, such as our competitors improved on-shelf availability to lessen as we exit Q3. In addition, we have strong plans in the back half that should help us step up our market share performance. We know that now more than ever that it's important for us to keep our brands in front of consumers and showcase them in ways that are relevant for the current environment. For example, our brands are leaning into consumer moments like gathering with trends for game night tacos with Old El Paso and making family memories over the holidays with Pillsbury rolls, breads and cookies.
We're also partnering to provide value-added incentives to consumers such as our free storage initiatives on [indiscernible] fruit snacks or free milk with participating purchases of Big G cereals. And as consumers continue to feel pressure, we're reminding them of the convenience and value that we deliver every day through products like Totino's Pizza Rolls and Blue Buffalo Life Protection Formula pet food. Through the first half of fiscal '24, our media investment was up high single digits, and we expect it to continue to outpace sales growth for the full year. In addition to investing behind our brands, we're accelerating our innovation pressure and expect full year sales from innovation to be higher than last year as we continue to build back to pre-pandemic levels. We're excited about the portfolio of innovation planned across our global platforms and local gems in the back half. Fiscal year-to-date, General Mills Cereals represent 4 of the top 5 launches in the U.S. cereal category, and we plan to build on that success with our new loaded cereals platform. These products feature a vanilla cream filling wrapped in a crunchy shell of our iconic brands like Cinnamon Toast Crunch, [indiscernible] and Cocoa Puffs.
In the yogurt category, following the successful first half introduction of Haagen-Dazs Culture Cream, we are launching Yoplait protein in January. This product delivers great taste and a smooth creamy texture with the added benefits of 15 grams of protein and only 3 grams of sugar. We are adding new flavors to successful product lines like Double Chocolate Chip Nature Valley Muffins and new Pistachio and cream and [Sesame] Tart varieties of Haagen-Dazs Pines.
And we're continuing to drive humanization and pets with launches like Tastefuls [Purees], as as well as expanding into the pet supplement space with our recent acquisition of Fera Pet Organics. Finally, to compete more effectively, we are focused on continuing to improve our in-store execution. In North America Retail, we're making progress on key fundamentals that tend to be a leading indicator for stronger sales growth and market share performance. For example, we gained or held share distribution at 85% of our U.S. priority categories in the second quarter, which was up from an already strong 71% in Q1. And we've secured important wins with customers recently to keep this momentum going into calendar 2024. We've improved our merchandising effectiveness by securing greater display support, helping keep our brands top of mind for shoppers and driving increased promotional lifts versus last year. And we leveraged our investments in online and connected commerce capabilities to show up with excellence at the digital shelf. Our retail sales through U.S. e-commerce channels grew double digits in the second quarter, and we continue to enjoy higher overall market shares in e-commerce as compared to brick-and-mortar outlets. Turning to pet segment performance. Our Q2 organic net sales were down 4% and operating profit was up 18%. As we said last quarter, we have more work to do to navigate through the current challenging category dynamics and return the business to consistent top line growth. The U.S. macro environment continues to be a headwind to premium pet food as pet parents display greater mobility and value-seeking behaviors.
We're also seeing a more meaningful shift in channel performance with double-digit retail sales declines in the pet retail channel in Q2, only partially offset by low to mid-single-digit growth in the food, drug, mass and e-commerce channels. From a product portfolio standpoint, we're seeing the most acute challenge on our Wilderness product line, given its super premium positioning and greater exposure to the pet retail channel. In addition to challenging consumer dynamics, we've seen headwinds from pet food retailers further reducing the amount of inventory they carry as they work to improve their balance sheets. Our organic net sales results lagged retail sales by approximately 2 points in the second quarter despite lapping a significant retailer inventory decline in last year's second quarter. Since fiscal 2022, we estimate retailers reduced Blue Buffalo inventory by roughly 1.5 weeks in Q2, which has represented a significant but temporary headwind.
While customer inventory is not in our control, we are taking actions and adjusting our plans to better meet pet parent needs in this current environment. For example, we saw low single-digit retail sales growth in the second quarter on our Life Protection Formula product line, supported by advertising that reinforce the true Blue promise and the brand's ingredient superiority. On our treats business, we've introduced new seasonal items and added a smaller nudges treats offering that gets below the $10 price threshold. Taking these actions, we have seen improvement in retail sales performance in our Dog Streets business.
On Wet Food, we are leveraging our strategic revenue management and price pack architecture capabilities to deliver great value to the consumer and hit key in-store price points. This includes a wide variety of new value pack offerings launching in Q3. And while we've made some recent progress selling in smaller wilderness bag sizes to certain retailers, that product line continued to see headwinds in Q2 with retail sales down double digits. While we are encouraged by the progress we're seeing on Life Protection Formula and on our treats platform, we have further work to do on wet food and particularly on Wilderness to ensure the offerings meet the needs of today's pet parents.
Shifting gears to our second priority, improving supply chain efficiency. As we navigate the pandemic and periods of disruption that followed, we saw significant costs come into our supply chain as we prioritize keeping our products on shelf for our customers and consumers. With increasingly stable global supply chains, we have made good progress increasing the efficiency across our logistics network, optimizing our manufacturing systems, reducing levels of safety stock and shifting back to more efficient product reformulations. As a result, we now expect to deliver HMM cost savings of approximately 5% cost of goods sold in fiscal 2024, representing an increase from our previous 4% guidance and ahead of historical levels. For our third priority, we continue to maintain a disciplined approach to capital allocation, including investing in our operations, growing our dividend, retaining flexibility for mergers and acquisitions and returning excess cash to shareholders in the form of share repurchases. We were able to repurchase more shares than we expected in the first half of the year, and we now expect to reduce our average diluted share count by approximately 3% in fiscal 2024. With that, let me turn it over to Kofi to go into more details on our second quarter results as well as our updated guidance for the year.
Thanks, Jeff, and hello, everyone. Our second quarter financial results are summarized on Slide 16. Reported net sales of $5.1 billion were down 2% and organic net sales also declined 2% in the quarter, reflecting lower pound volume, partially offset by positive price/mix. As Jeff mentioned, results this quarter compared against double-digit organic net sales growth a year ago. And on a 2-year compound basis, organic net sales were up 4%. Adjusted operating profit of $989 million was up 13% in constant currency, driven by HMM cost savings, positive price/mix and lower compensation and benefits expenses, partially offset by input cost inflation, lower volume, higher other supply chain costs and deleverage. Adjusted diluted earnings per share totaled $1.25 in the quarter and was up 14% in constant currency, driven by higher adjusted operating profit and a lower share count, partially offset by higher net interest expense.
Slide 17 summarizes the components of our net sales growth in the quarter. Organic pound volume was a 4-point headwind to net sales, while we've generated 3 points of positive organic price/mix in Q2. Foreign exchange and the net impact of acquisitions and divestitures were not material to the net sales in Q2.
Shifting to segment results. Second quarter organic net sales for North America Retail were 2% below year-ago results that grew double digits. On a 2-year compound basis, organic net sales were up 5%. The North America Retail organic net sales growth outpaced U.S. retail sales growth in Q2 by about 1 point, reflecting stronger growth in Canada and non-measured channels. At the operating unit level, net sales for U.S. Snacks and U.S. Morning Foods were both down 6%. Net sales were up 2% for U.S. Meals & Baking Solutions and up 9% for Canada in constant currency. On the bottom line, constant currency segment operating profit was up 3% in the quarter, driven by positive price/mix and HMM cost savings, partially offset by lower volume, inflation and higher other input costs deleverage and higher SG&A expenses.
Moving on to our Pet segment results on Slide 19. Second quarter organic net sales were down 4%. Net sales were down mid-single digits on dry food, down double digits on wet food and up double digits on treats. As Jeff mentioned, pet parent mobility and value-seeking behaviors continue to create near-term top line headwinds, particularly for Wilderness and for our business in the pet retail channel. On the bottom line, second quarter Pet segment operating profit was up 18% in constant currency, driven by positive price/mix and HMM cost savings, partially offset by higher other supply chain costs, lower volume and higher SG&A expenses.
North America Food service organic net sales were flat in the quarter, with positive price/mix offset by lower pound volume, including the impact of short-term capacity constraints on bakery flour. We expect these constraints to ease in the third quarter, while we continue to drive stronger growth in our cereal, snacks, yogurt and frozen baked goods platforms. Marketing index pricing on bakery flour was a 2-point headwind in Q2. Looking at overall channel dynamics, away-from-home demand remains resilient, driven by a shift from full-service to quick service restaurants as well as increased traffic in non-restaurant channels such as education, hospitality and travel.
On the bottom line, North America Food service segment operating profit was up 17% in Q2 as we continue to work towards restoring the NAF segment operating profit margin back to pre-pandemic levels. Our International segment, second quarter organic net sales were flat to last year, with declines in Brazil, offset by continued growth in our distributor markets in Europe and Australia. Volume performance in the quarter was negatively impacted by multiyear inflation in Brazil and the economic slowdown in China. We drove strong retail sales performance in Q2 on two of the segment's key global platforms, ice cream and Mexican food. Second quarter constant currency segment operating profit roughly doubled from year ago results that included the impact of the Haagen-Dazs ice cream recall. International operating profit growth this year was driven by positive price/mix and HMM cost savings, partially offset by input cost inflation.
Slide 22 summarizes our joint venture results. Cereal Partners Worldwide net sales were up 11% in constant currency in Q2, driven by the positive price/mix, partially offset by lower pound volume. Haagen-Dazs Japan net sales were up 6% in constant currency, reflecting positive price/mix and strong contribution from innovation. Second quarter combined after-tax earnings from joint ventures increased 5% in constant currency, driven by higher after-tax net earnings at Haagen-Dazs Japan.
Our margin results are highlighted on Slide 23. Our adjusted gross margin increased 180 basis points in Q2 to 35% of net sales, driven by HMM cost savings and benefits from positive price/mix, partially offset by input cost inflation, higher other supply chain costs and deleverage. At this point, we've closed nearly all of the gap to our pre-pandemic adjusted gross margin level. On second quarter adjusted operating profit margin, we were up 240 basis points to 19.3%, primarily driven by higher gross margin and lower SG&A expenses as a percent of net sales.
Moving to other noteworthy Q2 income statement items. Adjusted unallocated corporate expenses decreased $39 million in the quarter, primarily driven by lower compensation and benefits expenses. Second quarter net interest expense was up $26 million, primarily driven by higher rates. The adjusted effective tax rate was 20.8% compared to 21.1% a year ago, driven primarily by favorable earnings mix this year. Finally, average diluted shares outstanding in the quarter were down 3% to $583 million.
Turning to the balance sheet and cash flow on Slide 25. First half operating cash flow increased 25% to $1.5 billion. Recall that last year, our first half net earnings benefited from a noncash gain on the divestiture of helper and suddenly [salad] businesses. This year's increase in first half operating cash flow was driven by higher net earnings, excluding that divestiture gain. Capital investments in the quarter totaled $294 million. We remain on track for capital investment to equal roughly 4% of net sales for the full year, and we returned $2 billion in cash to shareholders in the first 6 months of the year through dividends and net share repurchases, representing a 39% increase versus a year ago. On Slide 26, we provided an update to our key financial assumptions for fiscal '24. On the top line, we expect second half total enterprise organic net sales to be roughly in line with Q2 results. We continue to expect contribution from organic price/mix to decelerate but remain positive in fiscal 2024. The key assumptions for each segment for the second half of the year include, North America Retail organic net sales growth is expected to be roughly in line with Q2 results. We anticipate a modest improvement in volume, offset by deceleration of price/mix as we [wrap] prior year SRM actions. Organic net sales growth for the North America Food service segment and International segments is expected to step up in the back half. And Pet segment organic net sales results are expected to slow sequentially in the second half of the year, primarily driven by a difficult comparison to double-digit growth a year ago, including a significant retailer inventory build in the last year's third quarter. Moving down to the P&L. We continue to expect input cost inflation of 5% of cost of goods sold, driven primarily by labor inflation that impact sourcing, manufacturing and logistics costs. As Jeff mentioned, we expect to step up our HMM cost savings to 5% of cost of goods sold, and we'll continue to invest in the future with media investment growing ahead of net sales. Below operating profit, our expectations for net interest expense and tax rate remained broadly unchanged, and we now expect to reduce our average diluted shares outstanding by roughly 3%.
Based on these assumptions, you can now see our updated outlook for fiscal 2024 on Slide 27. We now expect organic net sales to range between down 1% and flat. Adjusted operating profit and adjusted diluted earnings per share are now each expected to increase 4% to 5% in constant currency. And we continue to expect free cash flow conversion to be at least 95% of adjusted after-tax earnings. With that, let me turn it back to Jeff for some closing remarks.
Thanks, Kofi. Let me wrap up with a few thoughts. Over the past 5 years, we've become a stronger and more nimble company. We've turned over 20% of our portfolio, and we transformed our organization and the way we work. As we navigate a more challenging demand environment in the short term, we'll keep focused on driving growth through innovation, brand building and in-store execution, while elevating our HMM cost savings program to protect the bottom line. At the same time, we remain confident in the long-term trajectory of our business. We'll continue to leverage our leading brands, advantaged capabilities, restate portfolio and improved ways of working to drive sustainable, profitable growth and top-tier returns for our shareholders over the long term.