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Stock Analyst Update

Yes, General Mills Is Attractive

We expect the wide-moat packaged foods maker's gross margins to bounce back and think shares are undervalued.

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Wide-moat  General Mills' (GIS) stock declined by a high-single-digit rate following third-quarter results. There is growing concern about the company’s profitability, as gross margin contracted 220 basis points to 32.3% on higher commodity and supply chain costs. However, we anticipate freight pricing to moderate over the next few years given increasingly tough comparisons, allowing these headwinds, which have been plaguing the entire packaged food space, to abate. Further, mix is the primary driver of our existing outlook for gross margin expansion. The company is incorporating Blue Buffalo's operations--which represent 7% of fiscal 2017 pro forma sales and have gross margin in the mid-40s--with General Mills' food business, growing gross margin just 10 basis points annually. Even after incorporating modest gross margin pressure from higher supply chain costs over the next few years, we expect our valuation to remain within a dollar or two of our $61 fair value estimate, with gross margin in the food business returning to the 35%-36% rate averaged over the past five years over a longer-term horizon versus the 34% rate seen year to date. As such, we continue to think that shares present an attractive opportunity for long-term investors, trading at a more than 20% discount to our valuation and note the firm's 3%-4% dividend yield stands to enhance returns.

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Sonia Vora does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.