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General Mills: Emerging-Markets Consumers Remain Bullish

Erin Lash, CFA

Erin Swanson: Hi, my name is Erin Swanson and I am a Consumer Products Analyst here at Morningstar. Today we have the pleasure of speaking to Don Mulligan, Executive Vice President and Chief Financial Officer at General Mills, to give us some insights into emerging consumer trends as well as what's kind of going on in the environment in general. Thank you for being here, Don.

Don Mulligan: My pleasure, Erin.

Swanson: Last year when I talked to Ken, the CEO, we talked about SKU rationalization from retailers and the fact that consumers were eating more meals at home. And while consumers continue to be strained, promotional spending has ticked out and so consumer product compaines are having to work harder to prompt consumers to spend on their products. Is the level of promotional spending that you've been implementing has that been driving volumes higher? And beyond promotions what do you do to motivate a consumer who is maintaining a tight grip on her purse strings?

Mulligan: Yeah, well, it is a certainly a great question in today's environment. I like to think we always work hard for the consumer, but maybe particularly hard over the last few years as all industries have. I think you have to put it in context a little bit. Our industry went through a spike in inflation in 2007, 2008 as a consequence we all have significant productivity initiatives underway. There was some pricing that went into the marketplace.

We then had a bit of a respite from that in 2010, actually had deflation in our fiscal 2010 that ended earlier this year. And we were not alone, that was pretty industry wide. So as a result you saw some people pushing that back into price. As we look forward in the longer term but even in our current fiscal year, our expectations will continue to see 4% and 5% inflation in that mid-single digit range. And there's a lot of factors, emerging market growth, biofuel policy, maybe some investment dollars moving into the soft commodities, but we think that's here to stay. And that may spike in a given year.

But because of that we believe and we're starting to see this year some moderation in the promotion. We expect in the back half of our fiscal year that we will see a little bit of price coming through and we think that's going to be true in the years to come.And again, not a lot. When we think about our long-term sales growth, low-single digits, the bulk is going to be volume and mix with a little bit of price.

Because we think about how again do we work hard for the consumer is first of all we want to offer the products that they are looking for and that's around taste and convenience and health. We also want to make sure we're doing it at the right price. And the food industry for the long-term has priced well behind inflation. I expect that to continue. The amount of real income spent on food is down dramatically today from what it would have been 10, 20, 30 years ago. That trend will continue. From our standpoint what we look at is we want to drive productivity. We want to drive our mix management before we have to think about pulling the price lever or the promotion lever and that has worked very well for us. We continue to expect it to.

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Swanson: And with regards to your relationship with retailers, a year ago, retailers were looking to really limit their SKU portfolio, the number of brands on their shelves and were really pushing private label. How has that relationship changed or evolved over the past year?

Mulligan: We have very strong retailer relationships and I'd say from a strategy standpoint, you are right, most retailers looked at the consolidation of the industry as well as the recession as a time to strategically lean into private label. There was I'd say mixed results. During the recession private label picked up share. Now again to put in perspective for food and beverage more broadly in the U.S. it's about 20% market share. In our category it's about 15%, but that's up from 14% couple of years ago.

I think a couple of things have moderated that. If you look at the tracking, private label has actually lost share over the past six to nine months. Part of it is pricing differential, the gap between branded products and private label has shrunk a bit, and that's enough to change people's behavior back to brands. Maybe hopefully that it signals a stabilization of some of the consumer economic health, how they are feeling, and so they are going back to more traditional buying habits.

But our view is we view private label or retailer brands as we call them as competition, just like we look at our branded competition. And we mark ourselves against them and we want to make sure that we have a meaningful benefit that allows us to charge a premium doing it at the right volume levels, and we have continued to grow. One of the topics that you mentioned was the retailers clearing some space on their shelf to put private label in. Well, there is a measure for that called distribution. How many products do you have on the shelf. General Mills is the only food company that's consistently seen a growth in our distribution even while the retailers are pursuing the strategy. I think that's a signal of both our consumer strength, strength with the consumers, but also the strength of our relationship with customers themselves, the retailers, and that's going to continue to play well for us as we look forward.

Swanson: We've focused right now up to this point on the domestic environment and obviously the domestic market has been challenging, but economic conditions are challenging around the world. So I guess what are you seeing both in terms of consumers and retailers internationally, broadly speaking maybe if there is a diverging trends?

Mulligan: Yeah, I'd say the economic situation is very bifurcated. I think in the U.S., Western Europe, the developed markets, the consumer is very cautious. It's a very price sensitive, value sensitive, and so lot of investors are talking about the U.S. business, or absolutely what's helping us win in Canada and Western Europe and Australia.

In the emerging markets, consumers are much more bullish, much more aspirational. They are seeing their wealth increase, albeit from a lower base, but seeing their wealth increase. So what a packaged goods company, a food company has to offer is going to be different from a taste profile standpoint, from a casing standpoint.

But the capabilities that we bring in terms of food technology capabilities, our ability to do market research to really understand consumer insights sell to the customer and then obviously market to the consumer, are still exactly what's need to win in those markets. It's a matter of just finding what categories are they most relevant in a given market. And we've seen a really good success particularly in our China operation in that regard in the emerging markets.

Swanson: Now consolidation or at least talk of consolidation both of brands and of companies in the consumer product space has picked up. I would like to talk about what your – where you feel that there are potential for acquisitions, both within the portfolio as well as maybe geographically and then beyond acquisitions kind of what your priorities are for the significant amount of cash that you generate?

Mulligan: Sure. First of all, we are very pleased with our portfolio. One of the things really I think differentiates us is the fact that we have a portfolio of categories and brands that has inherent growth rate higher than the industry. And we can track that across the U.S. in particularly with the measurements that we have.

So first of all, we love our portfolio in terms of the categories we're in, brands we're in. I'd say as we look forward, there's not holes we want to fill in our established markets in the developed markets. It's going to be within categories that we're in today, so playing out more in the snack, the grain bar line, for example. If you look internationally, it's really about expanding our emerging market footprint. I mentioned we have a very strong business in China.

We have I'd say startup businesses in India, Brazil, Russia that we think can be a lot larger. We know we have the capabilities and that's where finding the right category to apply those capabilities is going to be critical and that will undoubtedly entail acquisitions of some sort. They will be smaller, really more bolt-on and ones where we can clearly both see and articulate externally how we're going to create value.

So, as we think about our use of cash and we do generate a substantial amount. There's was a bit over $2 billion last year and it will continue to grow with the rate of our earnings. First is capital spending. We are blessed with lot of reinvestment opportunities to grow our business. So that will average around 4% of sales, and it could lumpy year-to-year but kind of in that range. After that is dividends. We've paid dividends without interruption or reduction for 112 consecutive years. We will grow our dividend with earnings. So, our payout ratio remain relatively constant. And then we're not looking to accumulate cash, so the balance will be for share repurchase or for these opportunistic M&A activity that comes along. And from a on the organic side from a share repurchase standpoint we have and will continue to take off about 2% of our shares a year.

Swanson: Thank you very much for speaking with us today, Don. We really think General Mills has sustainable competitive advantages and is allowing them to standout in the packaged food space. So, thank you very much.

Mulligan: Appreciate that sentiment. It's a pleasure to be here.

Swanson: Thank you. This is Erin Swanson for Morningstar.