A top pick for growth & income

Consumer stocks tend to add stability to a portfolio. That’s because these firms sell items, like food, that consumers must buy, regardless of the direction of the economy.

General Mills is a top choice in the Consumer sector. The company has been cutting expenses and raising prices in response to higher ingredient costs. This should spur long-term earnings growth, especially now that commodity prices have fallen. Lower costs will also free up cash for expansion and dividends. Moreover, General Mills should benefit from its growing international presence, as some countries may well see a faster recovery (and corresponding rise in consumer spending) than others.

GENERAL MILLS INC. $65 (New York symbol GIS; Conservative Growth Portfolio, Consumer sector; Shares outstanding: 326.6 million; Market cap: $21.2 billion; Price-to-sales ratio: 1.5; WSSF Rating: Above Average) is the second-largest cereal maker in the U.S., after Kellogg. Its main brands include Cheerios, Wheaties, Lucky Charms, Total and Chex.

The company also makes a wide variety of other foods. These include Yoplait yogurt, Green Giant canned and frozen vegetables, Betty Crocker baking mixes, Pillsbury frozen dough, Progresso canned soups and Haagen-Dazs ice cream.

General Mills has three main divisions: The U.S. retail division (68% of sales) sells products to supermarkets and other mass merchandisers. (Wal-Mart accounts for around 20% of the company’s total sales.) The international division (18% of sales) manages General Mills’ overseas operations. The bakeries and food-services division (14%) mainly sells to restaurants, school cafeterias and vending-machine operators.

The company’s sales rose 30.7%, from $11.2 billion in 2005 to $14.7 billion in 2009. (General Mills’ fiscal year ends May 31.) Earnings climbed 24.3%, from $1.1 billion in 2005 to $1.4 billion in 2009.

The company is an aggressive buyer of its own shares; it aims to buy back 2% of its outstanding shares each year. Because of fewer shares outstanding, earnings per share rose 45.3%, from $2.74 in 2005 to $3.98 in 2009.

In the three months ended August 30, 2009, General Mills’ earnings per share jumped 33.3%, to $1.28 from $0.96 a year earlier. The latest earnings exclude a $0.03-a-share loss on hedging contracts that the company uses to lock in prices for wheat, corn and other raw materials. The year-earlier earnings figure excludes a $0.17-a-share hedging loss. Sales rose 0.6%, to $3.52 billion from $3.5 billion.

Focus on new products, marketing

In the past few years, General Mills has raised its selling prices in response to rising raw-material costs. These costs have since stabilized, so the company will now look to increase its sales with new products, instead of relying on higher prices.

General Mills spends around 1% of its revenue developing new products and packaging. It spends a further 5% on advertising. Accounting rules force the company to immediately write off these outlays. However, when done right, spending in these areas can spur sales and earnings for years to come.

For example, the company continues to develop healthier versions of its foods, such as low-sodium soups, and gluten-free cereals for people who can’t digest wheat. General Mills earns higher profit margins on premium foods like these than on its regular products.

General Mills is part of a food-industry group called Smart Choices, which aims to promote the health benefits of various foods with a “Smart Choices”seal of approval.

The company recently came under fire from the U.S. Food and Drug Administration (FDA) over Smart Choices’ claim that Cheerios cereal helps lower cholesterol. The FDA feels there is little medical evidence to support this claim.

Smart Choices has suspended operations until the FDA issues new guidelines for nutrition labels. It’s unlikely that this controversy will hurt Cheerios sales.

Overseas expansion will fuel growth

General Mills’ other main focus is emerging markets, such as China and India, where higher living standards are making its products more affordable to more people. The trend toward lower trade barriers should also make it easier for General Mills to increase exports to these markets. As well, it has a joint venture with Swiss-based Nestle S.A. that makes cereals in 130 countries outside the U.S. Joint ventures like this cut the risk of expanding internationally.

Moreover, the company’s strong balance sheet gives it plenty of flexibility to fund new investments or buy other firms. General Mills’ long-term debt rose from $4.4 billion at the end of fiscal 2008 to $5.8 billion as of August 30, 2009. However, the increase was mainly because the company converted some of its short-term borrowings into long-term obligations.

The credit crisis has limited investors’ willingness to hold commercial paper, so this move lowers General Mills’ risk of not being able to roll over these short-term notes with new ones. Despite the increase, the company’s debt is still a moderate 27% of its market cap. General Mills also holds cash of $711.6 million, or $2.18 a share.

Low p/e ratio despite recent stock rise

The stock dropped from its all-time high of $72 in September 2008 to a low of $46 last March. It then rose to its current $65. The shares trade at 14.4 times the $4.50 a share that General Mills will probably earn in fiscal 2010. That’s cheap in light of its well-known brands, record of rising earnings and high market share.

General Mills has also increased its dividend eight times since 2004. The current annual rate of $1.88 yields 2.9%.

General Mills is a buy.