By Joseph Hogue, CFA
Sara Lee (SLE) was up more than 7% on Friday as the company announced the spinoff of its international coffee and tea business. Investors will receive stock valued at approximately $4.55 billion and a special dividend of $3 per share. Once the spinoff is completed, possibly around June, the company will have about $1.7 billion in debt and $300 million in cash.
Though a recent Barron's report shows a slight positive skew to shareholder returns for spinoff transactions, these events are often done when a suitable acquisition price cannot be attained. The fact that private equity or other companies were wary about picking up the coffee and tea business may be a red flag for potential investors and there is no proof that Sara Lee will be able to operate more efficiently as a smaller company.
Business & Industry
Sara Lee Corporation is a global manufacturer and marketer of brand-name food products primarily in meats, bakery, beverage and household segments. Major brands include Ball park, Hillshire Farm, Jimmy Dean, Senseo and Sara Lee.
The company has also recently completed the sale of its bakery business in Spain and Portugal, its refrigerated dough business in North America, and divested much of its international household & body care business.
The outlook for the food processing industry is fairly neutral. A marginal economic rebound in the U.S. should offset some pricing pressures from continued high commodity costs. Consumer spending has held up well with growth of 2.1% in the fourth quarter and a 4.6% savings rate. Still, the industry is a mature one and programs for cost reduction have already played out. Without an increase in marketing support, companies will find it difficult to pass costs on to the consumer.
Fundamentals & Competitors
A 36.6% surge in the price since October has left the stock relatively expensive versus peers and the industry. Other than investor enthusiasm, there is nothing in key statistics or fundamentals that would warrant the relative valuation in the shares. In fact, a weaker ROE and lower profit margin when compared to peers suggest that the stock should be relatively cheaper than the industry average.
On a comparables basis, the $1.00 forecasted earnings per share and a multiple at the industry average brings the stock price to $20.60 per share, a loss of around 5.6% from Friday's close. A discounted cash flow analysis, assuming 2.5% terminal growth and 7.25% cost of capital, values the shares around $21.58, just under the current price.
The excitement of receiving shares in a spinoff or the special dividend may draw investors into the stock. An analysis of the specific business units and value after the spinoff would be in order, but other valuation metrics appear to show no rush to buy the shares. After recent price activity, investors may want to wait for some of the enthusiasm to come out of the shares before accumulating a position.
Investors anxious to benefit from spinoffs may want to look at the Guggenheim Spin-off Fund (CSD). The fund invests in approximately 40 companies that have been spun-off within the past 30 months, but not more recently than six months. Companies tend to be small- and mid-cap. Current weightings heavily favor consumer discretionary (29.5%), consumer staples (17.7%), information technology (16.6%), and financials (13.4%).
Investors looking for opportunities in the food processors could look to stronger competitors like Campbell Soup Company (CPB) or General Mills (GIS). Both companies look attractive on a relative valuation basis and pay a higher dividend yield than Sara Lee. Operating margins at the two companies are fairly impressive for a mature industry with 15.9% and 16.2% for CPB and GIS respectively. The industry has generally followed the broader market but may outperform if the economy softens during the year.