Marcial: Sara Lee's Makeover Is Turning Heads

Sara Lee is almost done with a multiyear plan to shed underperforming businesses and boost its core operations, and several investment pros already find the makeover quite enticing.

Best known for its baked goods, Sara Lee (SLE) is a global consumer packaged-goods company that makes and markets a vast, diverse array of products. To consolidate and increase consumer focus on its more attractive product lines, the company has been busy in the past four years (as part of an ambitious five-year plan), transforming itself into a more profitable, cohesive, and efficient enterprise.

It has been selling or spinning off product lines that are less profitable, and committing more attention to brands that it thinks have the best potential to grow faster over the long term. It also aims to introduce new products to beef up revenues.

One of the areas Sara Lee wants to expand is healthier snacks. Management is committed to increasing sales by taking advantage of the growing popularity of such products. For example, demand for whole grain has been on the rise, so Sara Lee has introduced flour-blend breakfast items, including "Soft & Smooth" whole-grain white bread and English muffins. Other new products are Hillshire Farm Entre Salads, Senseo cappuccino, and more Soft & Smooth bakery products. Sara Lee is also launching Ultra Premium lunch meat, Caffiato iced coffee and tea, and Toastworks toasted sandwich.

In making a clear investment in innovation and marketing, "Sara Lee has been executing well," says analyst Timothy S. Ramey of investment firm D.A. Davidson, which owns shares. He rates the stock, which traded at 8.50 a share on Mar. 27, a buy, with a 12-month target of 13. The stock has been on the rise since hitting a 52-week low of 6.80 on Mar. 9, 2009.

Sara Lee is "building organic sales power," says Ramey, who believes it will continue shedding assets. One he predicts may be sold is Sara Lee's Household & Body Care unit, which he estimates is worth $3 billion. Who would be interested in buying? Ramey points out that either Unilever (UN) or Henkel would be logical buyers.

Unilever, apart from making branded and packaged consumer goods, including food, detergents, and fragrances, also manufactures home and personal care products. So Sara Lee's household and body care products would fit well there. Henkel also makes, among other goods, skin care products, hair dye, and soap.

$3.8 billion kitty

"Sara Lee remains our single best idea for 2009," says Ramey, as "we like the strong cash generation, the 4.2% dividend yield, and the prospects for meaningful growth." He forecasts earnings of 93 a share on revenues of $12.9 billion in fiscal 2009 ending June 30, and 89 on $13.2 billion in fiscal 2010. The drop in the 2010 profit estimate reflects the company's downsizing.

So far, Sara Lee has sold or spun off 40% of its businesses, generating $3.8 billion, which it has invested in product lines with more growth potential. It also expects to achieve cost savings in the range of $575 million to $800 million by fiscal 2010. The company forecasts that the transformation will expand operating margins to 12% by that year, from 7.7% in fiscal 2005.

In 2006, Sara Lee sold its European meats business to Groupe Smithfield (SFD) for $575 million, and spun off its Branded Apparel business, which is now called Hanesbrands (HBI) and trades on the New York Stock Exchange. Sara Lee also exited several businesses that it deemed unattractive, including the DSD Bakery and DED Foodservice units. It pulled out of a joint venture in Mexico involving a meat products business as well.

debt will get downsized, too

Sara Lee's five-year transformation should benefit the company over the long term, says analyst Steven Ralston of Zacks Investment Research, who also rates the stock a buy, with a 12-month price target of 15. The restructuring, started in July 2004 when Brenda Barnestook over as CEO, has already succeeded in making itself a smaller but leaner, more efficient, and more profitable enterprise, he notes.

Despite the global economic weakness, Sara Lee is on track to complete its restructuring this year, says Ralston, who points out that the company is also focused on cutting costs. The downsizing, he figures, will reduce its revenue base, from $19.6 billion in fiscal 2004 to about $13 billion in 2010. Concurrently, he estimates debt ought to be reduced from $4.8 billion to a range of $1.5 billion to $2 billion.

However, the potential for accelerated growth the transformation is expected to produce hasn't fully convinced most of the analysts who track Sara Lee. Only three of the 13 rate the stock a buy. The other 10 recommend a hold or neutral. But what's more significant is that none of the Street analysts recommend selling the stock. Further signs of a successful makeover at Sara Lee may lure more Wall Streeters into the "buy" camp.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

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