Introduction

Thanks to their predictable cash flows (as they are less prone to economic shocks) and shareholder-friendly policy, consumer staples stocks are one of the most perfect income sources to allocate defensive money to. Nevertheless, these unsexy stocks have been beaten down recently due to fears of rising interest rates which will eventually affect their cash flows. The biggest question investors should ask themselves is how they want to play these stocks. In this article, I'll take a closer look at General Mills' fundamentals and technicals and how I plan on getting into shares using options. You can find more information about my favorite option strategy on my website right here (where I share my real portfolios).

General Mills' Fundamentals

Through M&A, General Mills' revenues have surged over the past several years. However, these movements came hand in hand with a massive debt burden. Adding the difficult industry circumstances, General Mills' share price has suffered huge losses over the past several months as investors doubt the sustainability of its profits margins. In its latest financial results, the company reported a negative organic growth rate, however, margins surpassed my expectations with a YoY improvement of 0.4%. Much to my surprise, General Mills made progress in downsizing its long term-debt from $12.6B to $12.2B, which is definitely good to notice. Nonetheless, investors remain clearly bored with General Mills' debt pile. So first we need to assess whether its free cash flow is able to deal with today's inflated balance sheet. Using the metric FCF/interest costs should give us more colour on this matter.

(Source: Author's Work)

At first, General Mills' safety margin has shrunk over the past 6 years due to a higher indebtedness rate, but this evolution must not be exaggerated as there's no indication of financial stress. Furthermore, cost savings from its recent takeovers (Blue Buffalo) are expected to gain traction and should lower the strain on the company's financials. 

GIS Free Cash Flow Yield (TTM) data by YCharts

GIS Financial Debt to EBITDA (TTM) data by YCharts

GIS Revenue (TTM) data by YCharts 

All in all, things don't look worse with a dividend yield that is largely backed by its FCF's and has recently hit the highest levels since the Big Financial Crisis. Defensive investors looking for predictable income should definitely watch General Mills shares.

General Mills' Technicals

As mentioned at the beginning of this article, General Mills shareholders had a 'challenging' 2018. Fortunately, we now see shares recovering some of the losses. Since November last year, General Mills shares have been rebounding to the upper side of the declining trend line, which creates opportunities for option investors.

(Source: Marketscreener software)

Looking at General Mills' upside potential, I expect the $42.32-$42.50 zone to be a tough short-term resistance, based on the 50% Fibonacci retracement barrier which comes in at the same level like the declining trend line. 

Trade Setup: Selling Cash-Secured Puts

Right now, I don't have any General Mills shares, but I wouldn't mind buying some as it is a reliable income-oriented asset that generates enough free cash flows to service interest costs. So I'm looking to pick up shares at $40 by selling cash-secured put options. These contracts don't have intrinsic value right now, meaning we can collect time value along the way if shares stay above $40. But as outlined above, given General Mills' financial situation, this strike price is reasonable to get into it.

(Source: Yahoo Finance)

If shares get assigned in February, I would buy shares at $39.61 (strike minus collected premium) and immediately sell calls against my new position. If shares stay above $40, then we would definitely lock in a return of 0.93% or an annualized 11.2%.

(Source: Author's Work)

Investor Takeaway

General Mills shares provide everything I am looking for: a mouth-watering and safe dividend yield, and a business model that is less prone to economic shocks. Its balance sheet carries huge amounts of debt, however, cost savings from its recent takeovers should start to pay off this year. More importantly, interest costs are still backed by free cash flows, putting the company in a comfortable position to downsize its inflated balance sheet. Moving on to my trade setup, General Mills' chart indicates that some cooling down may be near, which is why I've chosen to sell the out-of-the-money puts to benefit from time value decay while taking the opportunity to buy shares at $40 if that drop were to happen.

At request of my readers, I plan on writing follow-up articles about my option ideas and the return they've generated. More information about my portfolios can be found on my website.