Inside Wall Street: A Little Inflation Isn't Slowing Down General Mills

Embrace inflation. That appears to be the buoyant mood at some makers of packaged consumer food. Dire warnings about the advent of higher prices notwithstanding, not everyone in the consumer-staple sector expects to be a sorry victim of inflation.

Count General Mills (GIS) among those who aren't afraid of the inflation bogey. General Mills has met the issue head-on by being the first among the largest U.S. producers of ready-to-eat breakfast cereals and other brand-name consumer foods to raise prices on many of its products. In early January, it boosted prices on snack bars by roughly 7%, in addition to recent price increases on about 50% of its other U.S. retail brands.

The move has, interestingly, elicited kudos from analysts and investors. Wall Street remains upbeat on General Mills. None of the 23 analysts who follow it is down on the stock, currently trading at $36 a share. Nineteen analysts rate it a buy, with 12-month price targets ranging from $41 to $45. The four other analysts rate the stock a hold.

No Major Damage to Margins

"It's time to embrace inflation," notes Judy E. Hong, analyst at Goldman Sachs, in commenting on General Mills' move to ride with rising prices. Rating the company a buy, she says "General Mills remains our top food pick, and the snack bar price hikes reinforce our conviction."

Profit margins aren't likely to be dented as much as some predict. "General Mills is running extremely efficiently, and in fact profit margins can grow despite the increased cost of food," argues Justin Towey, managing director at money-management firm High Tower's Morse, Towey & White Group. General Mills' major competitors have also raised prices, including Kellogg (K) and Kraft Foods (KFT), although Towey says he's "less bullish" on them for other reasons. Analysts argue that their coincident moves to boost prices reduces the risk of any softness in sales volume.

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Wheat and corn combined only represent 14% of General Mills' cost of goods sold, and about 8% of retail prices, assuming a 20% markup, says Towey. That means even a significant jump in costs would necessitate only a modest price increase to offset the impact on margins, he figures.

Towey sees General Mills as a core long-term investment in the packaged consumer-food industry. His target for the stock is $45 a share, and he notes that the stock's dividend yield of 3.1% provides a nice cushion. Steadily rising revenue, earnings, dividends and cash flow growth, combined with its globally recognized brand name, make General Mills a real value in the large-cap consumer-staples group, says Towey.

Indeed, the company's brand-name products, including Cheerios and Wheaties cereals, Green Giant canned and frozen vegetables, and Pillsbury baking products, have attracted hordes of loyal consumers.

Continued Earnings Strength

"We generally like the company's brand strength," says Tom Graves, analyst at Standard & Poor's, who recommends the stock as a strong buy. He thinks the widely popular names will provide some protection against competitive pressure from the less expensive private-label products. The company has opportunities, he adds, to bolster long-term profit margins by focusing on areas such as manufacturing, spending efficiency, global sourcing and an expanded sales mix.

Graves predicts that earnings strength at General Mills will continue. For fiscal 2011 ending on May 31, he forecasts earnings popping up to $2.48 a share, from fiscal 2010's $2.24. In fiscal 2009, the company earned $1.90.

Evidently, the company's sound financial profile enhanced by a comfortable dividend yield have made General Mills a popular stock among conservative, income-oriented investors. Some large institutional investors are already big shareholders, including State Street Global Advisors, which owns a 6.42% stake; BlackRock Institutional Trust, which holds 3.7%; and Vanguard Group, which also owns 3.7%.

In sum, General Mills could be an attractive bet for investors looking for a large-cap stock that could outperform and provide a comfortable refuge, even if inflation does become more worrisome.