With the economy picking up, the food business is in for meaningful gains. Perhaps nowhere will these gains be strongest than for small producers. Fact Corp (OTCPK:FCTOA) and Health Enhancement Products (HEPI.OB) are two significantly undervalued firms. Given my background in investor relations, I can say with confidence that these firms are discounted primarily due to the fact that they are under-covered. As press coverage improves (and I plan on publishing focus articles on them), so too will their stock prices.
In the meanwhile, the attention will unreasonably center around giants like Sara Lee (SLE). In this article, I will run you through my DCF analysis on the firm and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Tyson Foods (NYSE:TSN) and ConAgra (NYSE:CAG). Overall, I find that Sara Lee is overvalued at the present moment.
First, let's begin with an assumption about revenues. Sara Lee finished FY2011 with $8.7B in revenue, which represented a 4.1% gain off the preceding year. Analysts model a 11.7% per annum growth rate over the next five years, and I view this as overly aggressive, given the weak momentum. For the sake of presenting my argument, however, I will "go with the flow" and accept the projection.
Moving on to the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I expect cost of goods sold to eat two-thirds of revenue versus 24% for SG&A and 4.3% for capex.
We then need to subtract out net increases in working capital. I expect this figure to be at around -0.5% of revenue. Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 8% yields a fair value figure of $19.06, implying 12.6% downside. This figure is, if anything, optimistic since the discount rate is very low and coupled with, in my view, overly aggressive growth expectations.
All of this falls within the context of a proposed split, wherein the company will divide into: (1) a retail & food business, and (2) an international beverage & bakery business. According to management:
"[I]f you split out our meat products from our bakery products, you see a more rapid improvement. That's a helpful perspective. The trends in meat products are improving rapidly both on the retail and on the Foodservice side".
While the split is attractive, the company is inflated from a multiples perspective. It trades at a respective 75.2x and 21.2x past and forward earnings versus 12.2x and 8.4x for Tyson and 14.6x and 13.5x for ConAgra. Assuming a multiple of 16x and a conservative 2013 EPS of $1.02, the rough intrinsic value of Sara Lee's stock is $16.32.
Consensus estimates for ConAgra's EPS forecast that it will grow by 3.4% to $1.81 in 2012, and then by 8.3% and 8.2% more in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $1.87, the stock is roughly at fair value. While I like the acquisition of the National Pretzel Company and the emerging market penetration, overly aggressive takeover activity will just be dilutive. Typically, efficiency comes through increases to scale; but, unnecessary extensions have the opposite effect. With costs rising around 10% this year, the company cannot afford to lose its pricing power.
Tyson, on the other hand, impresses me. Not only does it trade at the lowest multiples, but it delivered an excellent first quarter performance. Meat prices may be painfully low, but management is taking the appropriate steps to invest in emerging markets. The product line is almost entirely characterized by momentum. If only the stock hits a multiple of 8.4x next year, when peers are expected to be trading at 75.2x and 14.6x, the downside appears minimal.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.