- General Mills has rallied with rising inflation
- The earnings do not provide evidence of an inflation-driven boost
- Wall Street consensus outlook is neutral with no expected 12-month upside
- Market-implied outlook (calculated from options prices) continues to be slightly bullish
For companies that sell processed food products, inflation can be either good or bad. In general, however, rising food prices allows companies like multinational consumer foods manufacturer, General Mills (NYSE:GIS) to increase prices on its products. The earnings impact depends on how quickly commodity costs rise.
GIS reported FY 2022 Q2 earnings Dec. 21, missing the consensus expected EPS by 5.5%. Management attributed part of the earnings miss to commodity price inflation as well as the tight labor market, noting that the company had not been able to increase prices fast enough to keep up with inflation.
Source: Investing.com
The shares rallied in the second half of 2021—not least because investors often expect inflation to be a tailwind for food companies—and closed at a mid-year low of $56.79 on Sept. 7 and then rose 23% to a 12-month high close of $69.90 on Jan. 14, 2022. This rally was interrupted by a decline in the share price around the FY Q2 earnings report, but the shares quickly bounced back. The shares have fallen by 4.9% since Jan. 14.
The substantial gains in the share price in the second half of 2021 must reflect investor expectations of higher earnings in the future because the realized/reported quarterly earnings in the calendar year 2021 were slightly below those in the previous year. In other words, there is no evidence to suggest that rising inflation will boost earnings for GIS.
Source: E-Trade
GIS has a dividend yield of 3.03%, but the dividend growth has been very low in recent years, with 3- and 5-year dividend growth rates of 1.3% and 1.4% per year, respectively. The valuation is somewhat high, with TTM P/E of 18.6, as compared to the 5-year average of 16.6.
On Aug. 25, 2021 I assigned a neutral rating to the shares. The fundamentals continue to suggest low expected earnings growth. The Wall Street consensus outlook for GIS was neutral, with an expected 12-month price appreciation of 4-6%.
Along with looking at fundamentals and the Wall Street consensus outlook, I rely on the consensus view among traders that is implied by options prices, the market-implied outlook. The market-implied outlook (explained in the next paragraph) was bullish in late August. In balancing the neutral Wall Street consensus with the bullish market-implied outlook, I settled on a neutral rating due to the muted growth outlook. From the close on Aug. 25 to today, GIS has returned a total of 17%, including dividends, as compared to -3% for the S&P 500.
The price of an option on a stock reflects the market’s consensus estimate of the probability that the stock price will rise above (call option) or fall below (put option) a specific level (the strike price) between now and when the option expires. By analyzing prices of call and put options at a range of strike prices, it is possible to calculate a probabilistic price forecast that reconciles the options prices. This is the market-implied outlook and represents the implicit consensus outlook among buyers and sellers of options. For more details, see the link above or, for more quantitatively-oriented readers, this monograph from the CFA Institute.
I have calculated market-implied outlooks through 2022 and compared them with the current Wall Street consensus outlook in updating my view on GIS.
Wall Street Consensus Outlook For GIS
E-Trade calculates the Wall Street consensus outlook using ratings and price targets from 12 ranked analysts who have published their views within the past 90 days. The consensus rating is neutral, as it has been since the start of July. The consensus 12-month price target is $67.33, 1% above the current share price. While the individual analyst price targets range from a low of $56 to a high of $74, the average suggests that GIS is fully valued. The fairly high dispersion in the price targets suggests that there is little agreement on the outlook for GIS.
Source: E-Trade
Investing.com’s version of the Wall Street consensus is calculated using the views of 18 analysts and is neutral with a 12-month price target is $66.06, about 1% below the current share price.
Source: Investing.com
These two versions of the Wall Street consensus outlook agree that the overall outlook is neutral/hold and that the shares have no expected price appreciation over the next 12 months.
Back in August, the consensus ratings from E-Trade and Investing.com were also neutral, but the consensus 12-month price targets were 4% (E-Trade) and 5.9% (Investing.com) above the share price at that time.
Market-Implied Outlook For GIS
I have calculated the market-implied outlook for the 4.4-month period from now until July 15 and for the 10.6-month period from now until Jan. 20, 2023, using options that expire on these dates. I chose these two expiration dates to provide a view to (approximately) the middle of 2022 and for the full year.
The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
Source: Author’s calculations using options quotes from E-Trade
The market-implied outlook to July 15 is generally symmetric, although the maximum probabilities are tilted to favor positive returns. The annualized volatility calculated from this distribution is 24%.
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).
Source: Author’s calculations using options quotes from E-Trade
This view shows that the probabilities of positive returns are slightly, but persistently, higher than for negative returns of the same magnitude across a wide range of the most probable outcomes (the solid blue line is above the dashed red line over the left two-thirds of the chart above). This is a bullish outlook for GIS for the next 4.4 months.
Theory suggests that the market-implied outlook is likely to be negatively biased because risk-averse investors pay more than the fair value for downside protection. While we cannot estimate the magnitude of this bias, or even if it is present, the expected tendency means that the unbiased market-implied outlook may be more bullish than the results above suggest.
The market-implied outlook for the 10.6-month period to Jan. 20, 2023, exhibits closely-matching probabilities of positive and negative returns, although the probabilities of negative returns are slightly higher than for positive returns of the same magnitude (the solid blue line tends to be below the dashed red line). Given the expected negative bias, this outlook is interpreted as neutral. The annualized volatility calculated from this outlook is 24%.
Source: Author’s calculations using options quotes from E-Trade
The market-implied outlook to about the middle of 2022 is bullish, but the outlook for the full year is neutral. The bullish tilt over the next 4.4 months is less pronounced than the outlook from Aug. 25, which was for a five-month period. The expected volatility is 24% (annualized).
Summary
General Mills shares have rallied since the middle of 2021, apparently due to investors expecting inflation to provide a boost in earnings growth. So far, the earnings have not exhibited strong growth and, to the contrary, management attributed recent disappointing earnings to higher costs related to inflation.
The Wall Street consensus rating for GIS is neutral and the consensus 12-month price target is very close to the current share price. The market-implied outlook is bullish to around the middle of 2022 and neutral to early 2023.
While GIS may continue to rise for some number of months on expectations that earnings will ultimately benefit from inflation, the longer outlook is for muted earnings growth. I am maintaining my neutral view on GIS.