General Mills Profit Drops, Cites Rising Costs

General Mills Inc. (GIS) Tuesday reported a steeper-than-expected drop in quarterly net income due to higher food ingredient costs and stepped-up spending on promotions.

But the maker of Cheerios cereal (search) and Progresso soups (search) backed its full-year earnings forecast, saying price increases on some products, improved productivity, and lower commodity costs would boost earnings later this year.

General Mills, based in Minneapolis, reported a net profit for its first quarter ended Aug. 29 of $183 million, or 47 cents per share, dow earned 55 cents per share, below Wall Street analysts' average estimate of 60 cents, according to Reuters Estimates. General Mills shares eased more than 2 percent following the announcement.

Sales for the No. 2 U.S. cereal maker, behind Kellogg Co. (K), rose 3 percent to $2.59 billion.

Unit volume also climbed 3 percent but was offset by higher spending on promotions like discount coupons and store displays, for which there was more retailer demand than the company had expected, General Mills said.

Promotional costs are deducted from net sales under U.S. accounting standards, though they helped General Mills gain market share in yogurt, soup and popcorn, according to Nielsen data.

General Mills said in June it would hike wholesale prices on products such as soup and yogurt, to keep pace with rising food commodity costs. The move came on the heels of similar actions by rivals like Kraft Foods Inc. (KFT), who raised prices to pass on soaring dairy, soybean, and meat costs.

But consumers have yet to see higher prices on many General Mills products because of promotions the company committed to prior to the price hike, it said.

One analyst likened General Mills' position to that of consumer products companies Colgate-Palmolive Co., Coca-Cola Co. and Unilever Plc, all of which have warned of lower-than-expected profits in the last week.

"They're caught in the same vise," said Dave Kolpak, an analyst at Victory Capital Management, which owns 2.4 million shares of General Mills. "Very high raw material costs, inflation, and retailers are very reluctant to pass on price increases, so margins are being squeezed."

Supermarkets are reluctant to agree to price increases, because of competition from Wal-Mart Stores Inc., the nation's largest grocer, whose scale allows it to sell merchandise at prices most other retailers can't match.

In an interview, General Mills Chief Executive Steve Sanger said most of the price increases would be visible to consumers by the end of the year, though he also said they would be a challenge to pass through in categories where competitors were not raising prices, such as soup.

"In that case, I don't know what we'll be able to accomplish in the way of getting prices up," Sanger said on a conference call with analysts.

On a positive note, General Mills said food commodity prices should moderate in the second half of the year.

The company also said demand for carbohydrate-rich products like cereal, cake mixes and cookie dough rebounded during the quarter, a sign the low-carb diet craze may be waning.

Still, sales at the company's bakery and food service unit slipped 2 percent, though Sanger attributed the weakness to operational problems rather than the low-carb craze.

General Mills stood by its forecast of fiscal 2005 earnings of $2.75 to $2.80 a share, including 10 to 15 cents a share in one-time items. Sales are still expected to increase in the low-single digits on a percentage basis.

General Mills' stock fell 98 cents, or 2.1 percent, to close at $45.35 Tuesday on the New York Stock Exchange (search).