Sara Lee: Guidance Drop Spooks Investors

Sara Lee (SLE) managed to report first quarter earnings substantially above analyst forecasts. Sales were up 10% to $3.3 billion. Earnings were up 14% to 32 cents versus 28 cents or 39% higher than ‘Street” estimates of 23 cents. The company attributed the bulk of its success to impressive results at its North American Bakery Division. The Division saw its revenues climb 17% to $571 million, aided by unit volume growth and higher prices.

Guidance lowered: The company lowered its fiscal 2009 forecast about 12% from $1.16 to $1.03, primarily due to the strength of the US dollar. This still translates into a very reasonable 10 forward multiple, so I’m surprised the shares were hit as hard as they were yesterday, cratering more than 12%. Yesterday’s drop is overdone and provides another optimal buying opportunity.

Gross margin erosion: SLE’s gross margin declined 80 basis points from 37.90% to 37.10% due to higher input costs. Selling, General & Administrative costs saw some relief, falling 130 basis points from 32.4% of sales to 31%. SLE’s income tax rate jumped a staggering 530 basis points from 24.5% to 29.8%, eliminating 3 cents of potential earnings.

Cash dividend increased: SLE raised its quarterly cash dividend 5% in October, from 10.5 cents to 11 cents. This action creates a respectable yield of over 4%. The company has a seventy year history of continuous dividend payments.

Possible divestiture of non-food division: The company is interviewing investment bankers to evaluate the feasibility of selling its International Household and Body Care division. This division, which produces annual sales of over $2.2 billion, could fetch a multiple higher than SLE’s current ratio. Potential buyers include: Reckitt Benckiser, Henkel and Colgate. The proceeds would most likely be used to slash long term debt, which now stands at $3.9 billion.

Activist shareholder placed on Board: Jeff Ubben, Chairman of ValueAct Holdings who holds a 5.4% ownership position, was recently elected to SLE’s Board of Directors. His focus will be to promote ideas intended to boost the share price, such as divestitures and cost cutting measures. ValueAct is the third largest shareholder behind Brandes Investment Partners (7.35% ) and Barclay’s Global Fund (5.9%).

Bottom line: Yesterday’s pounding was overdone and presents a bountiful opportunity for value investors. Analysts' one year price targets of $15 seem reasonable at this juncture, and represent a whopping 50% return on investment.

Disclosure : Long