With a reputation for being shareholder friendly, Sara Lee's (SLE) management has been working on transforming the company to maximize value in the long term, as opposed to the short term. The consumer goods firm - that owns top brands, like Ball Park, Douwe Egberts, Hillshire Farm, among others - stunned many investors when it turned down buyout offers from JBS and a group led by Appollo Management. Since 2009, the stock appreciated by more than 84.6% while the S&P 500 (NYSEARCA:SPY) was only up half of that. It now trades slightly above its peers at a respective 33.2x and 17.1x forward earnings. For context, the forward earnings multiple for competitors follows: J.M Smucker (NYSE:SJM), 13.8; ConAgra (NYSE:CAG), 12.9; and Kraft Foods (KFT), 13.8.
Instead of selling itself, Sara Lee is opting to split itself into two units. One will produce food service & meat unit; the other, beverages. This strategic action is different from that taken by Kraft Foods in that Kraft is dividing itself more geographically. Kraft will focus on high global growth in one company and in high-margin products domestically in the other. As I explained earlier, this breakup will unlock considerable value, accelerate ROIC, and benefit the company most from a globalization catalyst. By contrast, ConAgra is seeking to grow through acquisitions, as it fights anemic growth. I am similarly optimistic about the effect that this will have on ROIC, although I believe the impact will normalize over time: see here.
Sara Lee appears to be targeting the best of both worlds. While it is streamlining operations through the breakup and sale of assets, management has also hinted at acquisitions in the meat business. Recently, the firm announced that it sold most of its North American coffee and tea businesses to J.M. Smucker for $350M and entered into a partnership that will result in $50M fee payments plus royalties. This will help reduce variable costs and improve geographical targeting while supplying Sara Lee with the necessary cash to acquire more brands for the meat operations. At the same time, Grupo Bimbo of Mexico is buying up the company's North American bakeries and Sara Lee is working on supply chain improvements for remaining ones. Sara Lee currently is third among Smucker, ConAgra, and Kraft in gross margins, 32.4%, although it is roughly tied with the average. Cost reductions could potentially boost gross margins to 36% or more by 2013 despite commodity volatility.
At the fourth quarter earnings call, CEO Marcel Smits commented about the input inflation:
Let me just zoom in on the commodity cost increases and remind you that we started the year expecting around $200 million of headwinds. That number is settled at $646 million, fairly close to our most recent estimates. Now faced with this challenge, we've been very clear on where we felt the priorities were. The first priority is to protect the long-term health of our margin structure and hence, our ability to innovate and support the brands. Not cutting our MAP spending to the bone is one element of protecting the long-term health of the business, and pushing through price increases is the other. And pushing for price increases, we've been willing to take short-term risks on the volume side, and we've been quite upfront about that. And meanwhile, we've pushed extremely hard to take as much cost out of the system as we could in order to protect our bottom line.
Now in all, we've seen a small decline in operating income and margin, as I've just said. Not something to brag about, but it was absolutely the right thing to do.
In the fourth quarter, adjusted revenue was up 5%, while adjusted operating income was down 2% - decent when you consider that the company absorbed $650M worth of commodity increases. Indeed, input inflation remains one of the greatest concerns for the company amidst macro stagnation. By splitting into two and selling off assets, the company can better market the meat business to help limit any drop in volumes. It will also better allow for acquisitions that will unlock the necessary revenue and cost synergies to weather a potential upcoming macro storm.
Consensus estimates for EPS are that it will increase by 16.7% to $0.91 in 2012 and then by 14.3% and and 16.3% in the following years. Absent the accounting of synergies, I model revenue growing by a CAGR of roughly 1% over 2012 - 2013. With a dividend yield of 2.58% and a commitment to transformation, Sara Lee is a solid defensive play.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.