Higher Trucking Costs Eat Into General Mills' Profit

Daniel Acker/Bloomberg News

Three months ago, General Mills executives believed the company was on the verge of simultaneous sales and profit growth for the first time in years. Instead, higher trucking and other costs suddenly ate into profit.

The company warned investors of the emerging trouble last month but, with the release of fiscal third-quarter results March 21, executives said the problem was even bigger and they significantly lowered their near-term profit outlook.

General Mills shares plunged 9% on the news, the biggest single-day drop in nine years.

Trucking companies are raising prices as they cope with higher fuel costs, a driver shortage and surging demand. General Mills has been forced in recent months to purchase more hauling on a spot basis, which is 30 to 60% more expensive than the contract rates it forges with trucking firms. During the latest quarter, just over 20% of its freight costs were paid at spot rates, up from the normal 5%.

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For now, the company is trying to qualify more truck companies for contracts and looking at lower-priced train hauling. But in the long run, General Mills will reassess the placement of its distribution centers and the entire process for moving ingredients and finished goods, said Don Mulligan, the company’s chief financial officer.

“That is a structural change that we are reacting to,” he said.

Executives outlined steps to tackle the cost problem, which was also shaped by higher prices for grain, fruits and nuts used in General Mills products. The challenge overshadowed its second consecutive jump in quarterly revenue.

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“We’ve seldom had a profit miss in a year such as this one when our sales are tracking at or better than planned,” said Jeff Harmening, the company’s chief executive. “We need to be just as agile in managing our cost structure as we’ve been in meeting consumer demands.”

With new products and refinements to existing ones, General Mills in the September-to-November period last fall arrested a two-year decline in sales. In the just-completed quarter that ended Feb. 25, those gains continued, led by cereal, its biggest product category, with a 2% jump of sales at North America stores. Snack bars and even baked goods and meals saw stronger sales in the latest period, too.

And yogurt sales, which have been down as much as 20% in the past few years, were down only 8%, helped by the success of the Oui yogurt launched last year.

“It’s not time to do a victory lap on yogurt,” Harmening said. “But we’ve seen consistent improvement due to fundamental innovation.”

General Mills, based in Golden Valley, Minn., also plans to launch another new yogurt line later this year, Harmening said, though he declined to give details.

But investors and analysts concentrated on executives’ views about cost pressures, trying to determine whether General Mills will be able to pass some of those costs on to consumers in the form of higher prices or will have to accept constrained profits for awhile.

“How much of what they’re able to pass through will depend on individual retailers, the characteristics of the various product categories and what competitors do,” said Brittany Weissman, an analyst at Edward Jones in St. Louis.

Executives laid out some cost-saving ideas and said they believe they have some flexibility to raise prices. But for the near term, with just one quarter left in the fiscal year, executives said full-year operating profit is now likely to fall as much as 6%, well below their previous worst-case of a 1% drop.

As a result of the cost increases, the company’s adjusted operating profit margin fell by more than a percentage point to 15.7% in the latest quarter. Its bottom line, however, rose sharply due to the accounting effect of the new federal tax law.

Net profit was $941 million, or $1.62 a share, about twice the normal level of General Mills’ quarterly profit. It earned $358 million, or 61 cents a share, in the same period last year.

In this quarter, General Mills recorded a provisional benefit to apply the new law’s tax savings to the earlier portion of its fiscal year. With that adjustment, its tax rate was 15.2% for the quarter, down from 24.7% a year ago.

Revenue in the latest quarter was $3.88 billion, up 2.3% from $3.79 billion a year ago.

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