Sara Lee: Future Uncertain For This Food Company

Aug.26.11 | About: Hillshire Brands (HSH)

Do you remember that old jingle from TV ads. Everybody doesn't like something, but nobody doesn't like Sara Lee. Well, I'm sure English teachers still cringe, although my late aunt, a first grade teacher, who made a successful purchase of this stock is probably more forgiving. When the stock market was in turmoil nearly 50 years ago following the assassination of JFK, she decided to do her patriotic duty and went out and purchased four shares of Consolidated Foods. The company would later be renamed Sara Lee.

For a long time she used the dividends to pay my younger brother to call her each morning to make sure she hadn't slept through her alarm clock. Later she began reinvesting the dividends. When she passed away several years ago, her four shares had grown to well over 1000 shares. And, she had some shares of Hahnes Brands, Inc., a company Sara Lee spun off to shareholders. Over the years, the investors in Sara Lee had as much reason to hum that jingle as did the consumers that bought the frozen cakes and pies.

Sara Lee began what might best be described as a haphazard acquisition spree in the late 1960's when it went beyond its core food businesses and began acquiring businesses as diverse as a chemical company and well known brands Kiwi shoe polish, Electrolux (OTC:ELUXF), Isotoner gloves, Coach handbags (NYSE:COH) and Playtex. In the late 1990's it started buying into the coffee business acquiring Chock full o'Nuts, Hills Bros., and Chase & Sanborn.

The past decade it began paring back by divesting Coach, the apparel businesses, and earlier this month announced it had signed an agreement to sell its North American Refrigerated Dough business to Ralcorp Frozen Bakery Products, Inc., a division of Ralcorp Holdings, Inc. (RAH). Ralcorp, previously spun off from Ralston Purina is currently being pursued by ConAgra (NYSE:CAG).

Sara Lee has kept busy the past year. After becoming an acquisition target it put itself up for sale, then decided that the prices offered weren't high enough or that the financing wasn't there. It has since announced it would be divesting more businesses, declaring a special $3 dividend and breaking the company into two businesses and spinning off the new company to shareholders in the first half of next year. Broadly speaking Sara Lee will spin off the international beverage business, primarily coffee and tea while keeping the Sara Lee, Hillshire Farm, Jimmy Dean and Ball Park brands.

When the company reported results earlier this month, the initial reaction was disappointment and the stock sold of sharply, hitting an intra-day low of $15.93 before closing above $17. While earnings, adjusted for discontinued operations, and revenue were in line with analysts expectations, the guidance fell short. For fiscal 2012 the Zacks Consensus estimate is $1.06 vs. company guidance of $0.89 to $0.95. Since the August 11th release date, Merrill Lynch upgraded Sara Lee "to buy with a $21 price target, as the firm believes that the breakup of the company should help the stock price".

Right now I'm more in the wait and see camp. Sara Lee was more aggressive in raising prices to cover rising raw material costs this past year and sacrificed market share. It needs to demonstrate that there will be similar profits in the two smaller companies and that costs can be contained while new SG&A systems and staffs are duplicated.

Going forward, management expects that it will regain market share as its competitors follow its pricing leadership. On the conference call it was indicated that some of this has already begun to occur. On the regulatory front, there are IRS rulings and additional divestitures. With all of these major issues, I am disappointed that the company is distracted with what appears to be a very silly legal battle with Kraft Foods Inc. (KFT).

The media is having a field day over the weiner wars with phrases about "legal beefs" and "dragging each other's buns into court." It is reminiscent of the old Miller Lite commercials where former athletes argued over whether great taste or less filling was more important. In this spat over Sara Lee's Ball Park franks and Kraft's Oscar Mayer wieners the issues are around ad claims of 100% beef and winning a taste test.

I have held Sara Lee stock for many years and will continue to hold. I have reinvested the dividends ($0.46 for a 2.6% yield) and will also continue to do so. I have also regularly sold out of the money covered call options to enhance my yield. Most recently (in mid-July), I sold the January 2012 $21.00 calls for $0.70. However, I see no reason to commit new funds to my position at this time. There are opportunities in other food companies that offer better yields and offer better growth prospects.

Disclosure: I am long SLE. I have no positions in any of the other stocks mentioned, and no plans to initiate any new positions within the next 72 hours.