General Mills: Hurt by Pullback in Brand Spending?

Beyond ensuring that new products are aligned with evolving consumer trends in the face of intense competitive pressures, we still think its tepid sales performance is being hampered by the decision to ratchet back brand marketing--media and advertising spend slipped 8% in the third quarter, following a 20% drop in the second quarter. As we’ve articulated previously, we portend that a pullback in brand spending has artificially inflated profit levels across the industry, and we viewed recent outsize profit gains as unsustainable. From our vantage point, firms throughout the space will need to bolster brand spending to offset intense competition (while also ensuring that its brand intangible assets persist longer term), a sentiment to which General Mills has provided credence. In this vein, our forecast calls for marketing to exceed 5% of sales the next 10 years, 40 basis points north of its average the past three years.

While we intend to review our assumptions, we don’t foresee a change to our $58 fair value estimate or our longer-term outlook--sales gains of 3% and operating margins around 20%, about 400 basis points above the historical five-year average (reflecting efforts to extract inefficiencies). Shares trade in line with our valuation, and we’d suggest investors await a larger margin of safety before building a position in this narrow-moat name.

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