When General Mills ( GIS) proposed the kinky marriage of the Pillsbury Doughboy and Betty Crocker with Hungry Jack and the Trix rabbit two years ago, executives bubbled over with enthusiasm about all the hot synergies they'd be cookin' in the kitchen. Chief Executive Stephen W. Sanger vowed that the $9.7 billion purchase of Pillsbury from Diageo ( DEO) would help to cut costs and fatten net income, vaulting the Wheaties maker into the topmost ranks of U.S. food companies. But Sanger has had to eat his words in recent months as profits have slipped backward in each of the past three quarters and revenue growth has ground virtually to a halt amid business-integration setbacks, stagnant marketing and a voracious attack by fortified competitors. Meanwhile, a mountain of debt and goodwill stemming from the acquisition rest like a gut bomb on the 136-year-old company's balance sheet, threatening its credit rating and net worth. Brokerage analysts have nevertheless upgraded General Mills' stock in the past week on grounds that it has held up relatively well amid the market downturn, offers a 2.8% yield, trades 25% off its all-time high, has stable cash flows and perches near a historically low valuation. No matter what happens in the economy, they add, people gotta eat.
Yet investors also gotta study the books, and no amount of relative charm and childhood nostalgia may ultimately distract them from concluding that the price of General Mills shares fails to account for the heap of trouble the company faces. Its plight is sadly emblematic of so many large industrials, as the lack of real growth has led the company to use a variety of additives to make earnings and cash flow appear healthier than they might really be. A close look by forensic accountants at MSN Money stock-research partner Camelback Research Alliance and work by other analysts suggest: Core earnings as roughly defined by the measure proposed by Standard & Poor's are lower than reported net income in recent periods, due primarily to pension and insurance-settlement gains. Reported revenue growth in the most recent quarters has come almost entirely from the Pillsbury acquisition, which virtually doubled General Mills' size. Once the impact of the acquisition is accounted for, sales growth has actually declined and is close to zero. Management's recent emphasis on earnings before unusual items essentially overstates profitability in relation to core earnings. Goodwill from the Pillsbury acquisition represents a significant portion of total assets and is more than 2 1/2 times stockholders' equity. General Mills' credit ratings are poor and worsening. That will make the refinancing of billions in short-term debt, due in 2003, difficult and expensive, affecting earnings. Why has the stock held up so well if the company's financials are soggy? Largely because most media and brokerage analysis of General Mills focuses on its undeniable food innovations rather than its underlying business methods. Reports typically begin with a glowing account of the way the company has leveraged its Big G cereal brands such as Wheaties, Chex and Cheerios into shelves full of bizarre mutations, such as Chex Morning Mix Honey Nut, Milk & Cereal Bars Chex, Wheaties Energy Crunch and Apple Cinnamon Cheerios. Any company innovative enough to turn a kid-unfriendly food like yogurt into squeezable Go-Gurt Cool Cotton Candy or Yoplait Whips Strawberry Mist, bulls say, must have a solid game-plan to reward shareholders.