“Down 112 points on the Dow Jones and only one making the 52-week high list, General Mills.” — CNBC’s Power Lunch 12/17/2009

General Mills (GIS) reported second quarter results that easily exceeded analysts’ expectations thanks in large part to declining commodity costs.  The packaged foods maker, known best for their cereals and Progresso soups, reported earnings of $1.54 per share excluding one-time items.  Analysts had projected earnings of $1.43.  Sales came in as expected at $4.08 billion, so it was improved margins that spurred the better earnings.  Lower commodity costs boosted gross margin by 4.1% in the quarter to an impressive 41.2%.  The company also benefited from better sales in high margin products such as Cheerios in the quarter.

The improved operating performance in the first half as well as “business momentum” prompted General Mills to lift guidance for the rest of the year as well.  Management guided for EPS of $4.52 to $4.57 for fiscal 2010 which ends in May.  This pushes guidance above consensus analysts’ view of 2010 earnings of $4.50. 

On the very successful quarterly numbers, General Mills hit new yearly high prices during Thursday trading at nearly $70 per share, and based on our methodology may be headed even higher.  The stock is currently trading below its historically normal range of price-to-sales and price-to-cash earnings, and those fundamentals are trending higher.  Earnings have benefited from easing in commodity costs and any incremental gains in sales will really boost the bottom line.  That is one reason that General Mills has boosted its advertising budget by 37 percent in the quarter in an effort to drive growth higher.  More consumers are eating at home these days, so GIS hopes to steer more purchases towards their products.  The improved margin also gives General Mills more flexibility for promotions and discounts to build brand loyalty.

We continue to rate GIS as Undervalued despite the stock hitting new highs for the year.  According to our methodology, this stock should continue higher, possibly into the $80’s before too long.  General Mills continues to execute well and clearly this stock is headed in the right direction.

“Third leg is very controversial but we don’t shy from controversy on this show. It’s WellPoint, now what is WellPoint, WellPoint is the HMO that reported an absolute monster yesterday quarter. Earning $1.53 per share or $1.78 excluding one time items.  16 cents or 41 cents higher than the street was expecting.  Wow.

Now everyone’s worried about health care reform. Especially with congress banging the health care drum all week. But I think the real story when it comes to WellPoint at least is its tremendous earnings power, the one that we saw demonstrated yesterday. Do you know that I don’t think that they could hide the earnings they were so powerful. Who wants to be an HMO and report big numbers right now. But they couldn’t help it. Even if we get a health care bill that knocks 25 cents off of WellPoint’s earning and I think tell probably be more like a dime. This shock is still cheap, trading about eight times earnings. Double-digit growth rate. I don’t have a stock just so that we are clear in my whole universe that has that growth rate with that low price to earnings multiple and stuff the stuff out of Pelosi this morning definitive move to the center to get everything passed. Emboldened us to think that maybe WellPoint’s earnings may not get dinged at all. I think that WellPoint goes to $53 by my calculation once the health care debate is over. Hey, I really don’t care how its resolved… <buy, buy, buy>”–CNBC’s Mad Money 10/29/2009

With the recent weakness in the stock market, Jim Cramer is sticking to his investment thesis that this market will continue higher based on the three-legged stool of oil, tech, and financial sectors.  However, each of these sectors have begun to look a little shaky based on less than impressive results from Exxon Mobil (XOM), Acer computers, and banks with credit concerns.  In order to give more stability, he is recommending adding a defensive fourth leg to his stool metaphor.

At Ockham, we do not take issue with reducing risk in your portfolio at this juncture and some of Cramer’s recommendations are likely great long term buys.  Those names include Procter and Gamble (PG), General Mills (GIS), Kellogg (K), and McDonald’s (MCD).  However, he also includes Wellpoint (WLP)as a safe stock, which is certainly surprising to anyone who worries about the legislation being discussed in Washington.

From a valuation perspective, we are in complete agreement that WellPoint is certainly attractive as the fundamentals have continued to improve for this huge insurer.  Furthermore, the fear of legislation has kept the stock down in very reasonable price levels.  As our historical ratings chart suggests, we have seen this stock as Undervalued for some time.  As Cramer points out, the double digit growth rate is exceptional with the low earnings multiple on WellPoint.  However, we are cannot agree that this stock is defensive.  There is still far too much up in the air in Washington that could adversely affect the HMOs. 

Cramer still likes this stock if you were to take 25 cents off of WellPoint’s earnings, but will the rest of the market agree?  Will the changes in Congress continue to eat away at the profitability of the HMO or could investors expect it to be a one time drop followed by stabilization?  What will happen to the growth rate of WellPoint?  Where does Cramer get his 25 cent or 10 cent expectations in the first place?  There are simply too many questions that are unanswerable for us to subscribe to the theory that WellPoint is part of a defensive strategy.  Simply because a stock is attractively valued does not mean that it is not speculative as well.

Cramer had solidified himself as the rally’s most bubbly cheerleader over the past six months, but as of Thursday night’s Mad Money it appears he is changing his tune.  While he is not projecting huge losses, he does think that investors should position themselves defensively for a 3%-5% pullback.  In discussion of his reasoning, he stated that his game plan this week was to watch the way the market reacted to earnings reports from General Mills (GIS), Bed Bath & Beyond (BBBY), and Paychex (PAYX) in particular. 

“So what’s happened this week? Sure enough, when General Mills reported a very good quarter, the stock exploded to the upside.  When Bed Bath & Beyond also reported a very good quarter, it got clobbered. Paychex, it said nothing good whatsoever about the employment rolls and that pummeled pretty bad, so it’s time to admit it’s time to admit that the negative scenario that I laid out last Friday is now playing out, which means we have to get a little bit more defensive here.

That’s what I’m doing from my charitable trust all day you can follow it all day at actionalertsplus.com. I’ve been taking profits in some those big industrial stocks that I told you to do on Friday if you saw this pattern. I’ve been going into more defensive names as I told you to do in the game plan because of this pattern and it’s because the market ended up liking Generals Mills and despising both Bed Bath & Beyond and Paychex. In other words we have to be a tad more cautious. Because the game plan said that if the market, as judged by the collective reaction from the news from these companies, chooses defense over offense, if it chooses the safety stocks over the aggressive ones, then we have to pull in if not bite our horns…The stocks are making sense and even if we don’t like what they’re say, I regard myself as kind of a stock whisperer which is kind of like a horse whisperer only more profitable and I’m telling you the game plan must be obeyed.” — CNBC’s Mad Money 9/24/2009

Love him or hate him, you have to laugh when he calls himself a “stock whisperer.”  However, there may be more to this quote than comedy.  His reference to the horse whisperer is perhaps coincidentally interesting because he is really basing his investment thesis on his gauge of “animal spirits.”  John Maynard Keynes originally coined the term animal spirits to describe human emotion and psychology and how it leads to boom and bust cycles.  Most recently, we have seen the market take on a more speculative behavior than normal in the hopes of greater returns on some of the riskiest issues, which has contributed to the market’s impressive rally.  However, Cramer is watching a shift in the investor psychology to a more subdued outlook, and he is adjusting his bullishness accordingly.  There is no way to really measure a thing like investor psychology, so it really comes from a feeling you have to gauge from watching the way the market reacts to news.

When a major bull like Cramer starts to soften his stance, it does not necessarily mean he is correct.  However, we never underestimate the legions of devoted Cramer viewers.  If you would like a recap of all of the stocks mentioned on last night’s Mad Money just visit our Mad Money recap page.  The chart to the right shows the stocks he talked about last night.

“General Mills meanwhile, first quarter profit jumping more than half versus a year ago. Way ahead of expectations thanks to lower commodity costs and higher sales of Cheerios, Pillsbury cookie dough, et cetera… Boosted the full year forecast above the prior range and shares jumping quite a bit this morning.” — FBN’s Money for Breakfast 9/23/2009

General Mills (GIS) impressed the Street this morning with the home run of earnings reports, the beat and raise.  Shares are surging more than 5%, as the packaged food giant was able to raise net income by 51% in the first quarter.  EPS came in at $1.28 which beat consensus estimates by about $.25.  The increased earnings were due not to huge sales gains, but rather improved margins from decreased commodity costs and other cost cutting measures.

Management emphasized continued strong consumer demand as General Mills was largely able to fend off private label products.  Sales were just a little better than flat, but the company did raise its full year earnings projections by 20 cents to $4.40 to $4.45, which is again well ahead of consensus estimates of $4.26.  General Mills has managed the recession with skill and clearly positioned itself to weather the storm, and they have beaten estimates in all but one report for the last to years.  They have not raised prices in most of their product lines, but shrinking costs allowed gross margin to expand to 41.5% from 34.1%.  Consumers are certainly staying home to eat more often (cereal makes a great cheap dinner), but in general they have not been tempted to trade-down from General Mills products to the often cheaper store brand, especially in regards to the all important cereal products.

At Ockham, we continue to believe that there is value in a stock like General Mills and we currently have an Undervalued rating on the stock.  Although the company has not showed impressive sales gains, they are getting much better bang for each dollar of sales.  Even still the stock looks attractive compared to historical price-to-sales per share valuation ranges.  Over the past ten years, GIS has normally traded for between 1.7x and 2.2x sales, but the current ratio is only 1.36x.  Furthermore, on price-to-cash earnings basis this stock also looks attractive.  Historically, it has ranged between 13.6x and 17.5x, but the current figure shows the market awards GIS only 11.2x cash earnings.  For these reasons, we think that even within spitting distance of an all time high, General Mills has further appreciation potential and could justifiably trade in the mid-$70’s.

“The FDA warned General Mills that some health claims made for Cheerios cereals violated the law, heaven help us! I had seen a squib about the FDA’s criticism the day before, didn’t think much of it. Right on the top left. Key area. Fabulous real estate. And I figured, okay, I own General Mills for my charitable trust, actionalertsplus.com, and I am going to be in for a really, really long, brutal day.

I figure the stock opens down at least a buck, as cheerios is a huge product for General Mills and the heart health claim may be one of the biggest differentiators for consumers when it comes to choosing which cereal to buy. When I saw the stock index futures plunging before the opening of trading I started thinking it’s going to be even worse…Thrown to $50.50 from $53.50, where it went out the night and you know what happens? General Mills opens virtually unchanged and then proceeds to rally. To rally. That, ladies and gentlemen is when the alarm bells went off in my head…

… This is an important product. Instead, it received no more than a glancing blow. Down 19 cents at the end of the day but up for much of it. Oh, sure, that’s a triumph for General Mills and the oh, sure, that’s a tragedy for cheerios, but it’s a tragedy for 90% of the market. And it is deeply worrisome you see, if General Mills is holding its own and the rest of its cohorts, the Pepsi and the Mercks and the J&J’s are all up, as they were on this hugely down day, then the market is saying it’s screaming something.” CNBC’s Mad Money Recap on Wednesday, May 13, 2009

What is Jim Cramer saying here?  Well, first of all he was surprised by the lack of an effect the FDA’s warnings had on General Mills (GIS).  As he mentioned, after the FDA’s announcement General Mills stock took a huge hit in premarket trading, but as soon as the trading day began General Mills was right back to where it had closed the night before.  The stock actually traded the rest of the day around even, as the rest of the market plunged.  Furthermore, other generally defensive names such as Pepsi (PEP), Merck (MRK), Johnson & Johnson (JNJ) were all up on Wednesday.

Cramer believes that this is a major signal that the market is turning to more defensive stocks in anticipation of a possible downtrend.  Could this be a sign of a reversal from the huge rally over the last ten weeks?  The first three days of the week were down, as the economic data has not shown the improvement that many had hoped they would.  It is still too early to say that the green shoots of growth have gone away, but there is mounting evidence that the rally has run out of steam. 

We will hold back our conclusions until we have more evidence from which to base our opinions, but we were skeptical that this rally was the beginning of a V-rally.  We have thought for sometime that the necessary economy wide deleveraging was going to confine corporate earnings to some extent for at least the next few years.  Long term performance of the market is driven by earnings, and the pace of the rally seemed unsustainable based on the earnings trends.  There is no telling what the future holds, but at least the beginning of the week was a signal that the recent rally had gotten just too hot.

“In the short run the market is a voting machine. In the long run it’s a weighing machine.”–Benjamin Graham