Better Safe Than Sorry: General Mills Stock Has Downside Risk

Source: Thinkstock

Source: Thinkstock

Investors sold of shares of General Mills (NYSE:GIS) on Wednesday as the company reported earnings that missed analyst expectations. The company reported $4.3 billion in sales for its fiscal fourth-quarter, which is 3 percent lower than last year. It reported $17.9 billion in annual sales, which was a 1 percent decline over fiscal 2013. While earnings per share came in at $0.67/share — 24 percent higher than last year — we should note that this includes a one-time $65 million gain, and adjusted for this the company would have grown its earnings per share by about 2.5 thanks to cost cutting.

General Mills is often considered to be a “safety” stock, meaning that investors can rely on it to generate consistent earnings and slow yet consistent growth over long periods of time. It is in an industry — packaged foods — that doesn’t see significant sales declines in a recession, as people need to eat and they are generally loyal to the brands they consume (e.g. Cheerios.)

However, “safety” stocks often lead investors to a point of irrational complacency, and this can be dangerous. General Mills has to deal with a lot of issues that threaten its business such as volatile input costs and enormous competition from both large and small competitors. So while the stock might seem compelling at 18 times earnings with a 3.2 percent dividend yield, I think investors need to consider that there is very real downside risk.

The first risk is volatile commodity prices. While agricultural commodities have been relatively weak as of late, they are in a long-term bull market that began about 10 years ago. There are more people eating more food while the amount of arable land remains the same. Meanwhile, input costs are rising making farming increasingly less profitable. This in turn means that individuals don’t aspire to become farmers, and as time goes by the number of farmers is declining while the average age of farmers is rising. This will put pressure on agricultural commodity prices in the long run, and this will pressure General Mills’ margins.