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Sara Lee: Why Investors Won't Bite

Shareholders of food companies have often reassured themselves that even in a recession, customers need to eat.

Unfortunately, that investing cliche has been little help in this downturn, as Sara Lee (SLE) demonstrated with a disappointing profit report on Aug. 12. Sara Lee shares tumbled 10% in response to the quarterly release, slipping back below the $10-per-share mark to 9.72.

Last quarter's earnings actually beat Wall Street predictions, with per-share earnings of 28¢ excluding one-time charges, 4¢ more than analysts had predicted. The trouble came from worse-than-expected sales, which fell 9.8% from a year ago. And Sara Lee's earnings predictions for the next year disappointed Wall Street.

"Things aren't turning around any time soon," says Greg Estes, manager of the Intrepid All Cap Fund (ICMCX), which owns shares of Sara Lee and rival Kraft Foods (KFT).

Other packaged-food firms have implied that the worst effects of the recession could be over, but Sara Lee's projections for next year don't seem to share the optimism, Estes noted. "Part of the problem is the economy," he says. But he adds that Sara Lee also has unique problems.

Consumers Cut Back, Emptied Pantries The effects of the recession have been a shock to many food industry executives and investors. Especially when the downturn intensified in late 2008, many consumers slashed spending on food at the grocery store, preferring to use up edibles stashed in their refrigerators and pantries, says Soleil Equity Research analyst Edgar Roesch. Since then consumers have hunted for bargains at the supermarket.

"You've seen a lot more cautiousness by the consumer," Roesch says. "They are seeking out value more than these food manufacturers expected."

Judging by their stock prices, the food companies that might be expected to outperform during a recession are actually underperforming. While the broad Standard & Poor's 500-stock index is up more than 11% this year, Sara Lee shares have fallen slightly, by less than 1%. Kraft is up 7%, while Kellogg (K) has advanced 6% this year.

Conditions have been tough for all food producers. Problems included last year's high commodity inflation, fierce competition, and a strong U.S. dollar eating into overseas profits. But Sara Lee has had unique challenges. "The economic downturn has hurt them more than the competition," says Eric Hare, an analyst at Al Frank Asset Management, which owns shares of Kraft and Sara Lee.

Sara Lee's specialties include lunch meats, bakery items, and other areas in which it's difficult for the company's brands to dominate. Kellogg's brands, by contrast, have been able to command an area such as breakfast cereal. But typically, "you're not attached to one kind of bread or bun," Hare says. Without strong brand names, "it's easy for people to just go for the cheapest alternative." And that's what many supermarket shoppers have been doing—choosing private label and store brand products and forcing major food companies to cut prices to compete.

CEO Barnes Promises a Turnaround Sara Lee does have some things going for it, both as a business and an investment. Compared with other food companies, the company's share price is inexpensive by such measures as price-to-earnings and price-to-sales ratios, Hare says. Sara Lee is also in the midst of a long process of integrating its various businesses, cutting costs and selling off less-profitable units. In 2006, Sara Lee spun off Hanesbrands (HBI). Sara Lee also has been trying to sell off its household and body care segments, but still owns substantial nonfood businesses, including the brands Pyrel, Ty-D-Bol, Endust, and Kiwi shoe polish.

Sara Lee Chairman and Chief Executive Brenda Barnes said on Aug. 12 that she expects annual cost savings of $350 million to $400 million by 2012. The company also says new innovative—and more profitable—products are on the way.

"Our commitment to innovation, marketing, and talent development are translating into bottom-line results despite some macroeconomic challenges," Barnes told analysts. "We are confident we are well-positioned to benefit as the global economy begins to recover."

Barnes is attempting to fix a company that has been a chronic disappointment to investors, with shares down 54% in the past five years. "The challenge has been trying to execute that in a very difficult environment," Roesch says.

Despite her efforts, the reality is that a brighter future for Sara Lee—and for the food industry in general—might not be possible until the economy shows real signs of improvement. Until then, cutthroat competition and penny-pinching consumers are creating tough conditions for this supposedly recession-resistant industry. Even though the shares look cheap, investors may want to wait before grabbing a slice of Sara Lee.
Steverman is a reporter for Bloomberg News in New York.

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