For the quarter, GIS generated EPS of $0.85, beating analysts' expectations by $0.04, while also extending its winning streak versus the consensus to four straight quarters. One of the more encouraging metrics in the report is that adjusted gross margin improved by 10 basis points. As readers are probably aware, GIS (and other commodity-driven businesses) have been pressured by higher input costs that put a squeeze on margins. Last quarter, for instance, adjusted gross margin declined by 160 basis points to 33.6%, due to cost inflation as well as headwind from a one-time purchase accounting charge related to its Blue Buffalo acquisition.
Margin improvement this quarter was driven by increased HMM (Holistic Margin Management) savings benefits from positive price realization and mix, as well as the addition of Blue Buffalo and tighter cost controls.
On the top line, revenue increased 5.0% to $4.41 bln, missing the $4.5 bln consensus. GIS' North America segment continues to struggle; sales fell lower by 3%, reflecting lower merchandising activity in the U.S. Cereal unit (volume down 7%) and lower volume for U.S. snacks. In the cereal unit, GIS implemented some pricing changes early in the quarter, and this change negatively impacted volumes. However, as those changes moved into the rear-view mirror, merchandising levels began to rebound later in the quarter, and the company is confident that the cereal unit will improve in 2H19.
That said, the softness in the company’s North America segment is not escaping management’s notice. During the earnings call last night, it stated that its job for the second half is clear: to accelerate sales growth in the North America Retail and Pets segment, while maintaining cost discipline.
On the topic of the Pets segment, GIS completed its acquisition of Blue Buffalo, a leader in the wholesome pet food industry, back in April. In 2Q19, net sales fell 7% as the company lapped a difficult comparison in the year ago period. Namely, in 2Q18, net sales jumped by 25% as Blue Buffalo first expanded into the Food, Drug, and Mass (FDM) channels. Overall, though, Blue Buffalo continues to look like a positive acquisition for GIS as it remains the fastest growing pet food brand and continues to gain share in the e-commerce channel, where it generates about a quarter of its sales. One of GIS' strategies in 2H19 is to launch Blue Buffalo to new FDM customers, doubling its ACV (all commodity volume) distribution by the end of the fiscal year.
In addition to its focus on sparking top-line growth, GIS believes it has a few levers to pull in terms of profit margins. For instance, last month it opened a new distribution center that will provide synergy savings, and it expects to see a more profitable product mix with a greater portion of FDM sales in higher margin areas, like wet and treat products.