valuation example sara lee (sle). what does sle do? food –meats to large intermediaries such as...

Valuation Example

Sara Lee (SLE)

What Does SLE Do?

• Food– Meats to large intermediaries such as supermarkets,

and foodservice distributors.– Bakery to large intermediaries and directly to

consumers.– Beverage retail and foodservice sales of coffee and

tea.

• Household Products: body care, hair care, shoe care, and insecticides. Sold to retail channels.

• Intimates and Underwear: Sold to retail channels.

SalesOperating Segment

Income

2003 2002 2003 2002

Sara Lee Meats 3,746 3,704 375 323

Sara Lee Bakery 3,276 2,976 98 97

Beverage 2,756 2,539 429 416

Household Products 2,118 1,962 369 339

Intimates and Underwear 6,399 6,455 763 596

Total business segments 18,295 17,636 2,034 1,771

Intersegment sales (4) (8) — —

Total sales and operating segment income 18,291 17,628 2,034 1,771

Amortization of intangibles — — (104) (77)

General corporate expenses — — (248) (301)

Total net sales and operating income 18,291 17,628 1,682 1,393

Net interest expense — — (198) (208)

Net sales and income before income taxes 18,291 17,628 1,484 1,185

I Will Read the Table Footnotes!(Straight from the 2003 10k.)

• Intangible amortization increased from $77 million in 2002 to $104 million in 2003 primarily as a result of a full year of amortization on intangibles acquired after the start of 2002, the acceleration of amortization on certain trademarks determined to have a shorter useful life and the impact of changes in foreign currency exchange rates.– This tells you what about the firm?

• General corporate expenses declined primarily as a result of lower minority interest expense, reduced spending on business process reengineering efforts and reduced costs of performance-based bonus plans.– This tells you what about the firm?

Relative Contribution by Division

Operating Income/Sales

before Depreciation

Fraction of Operating

Income

2003 2002 2003 2002

Sara Lee Meats 0.10 0.09 0.18 0.18

Sara Lee Bakery 0.03 0.03 0.05 0.05

Beverage 0.16 0.16 0.21 0.23

Household Products 0.17 0.17 0.18 0.19

Intimates and Underwear 0.12 0.09 0.38 0.34

Total business segments 0.11 0.10 1.00 1.00

Items to Note

• Bakery– Horrible all around. Earns very little per dollar sold, and

contributes almost nothing to the firm’s profits.

• Meats– Thin margins, but the division makes up for this in overall sales.

• Beverage and Household Products– Both divisions seem healthy under all measures

• Underwear– Margins are thin compared to beverage and household products.

– More than makes up for thin margins via sales and is by far the

biggest contributor to the firm’s profits.

Some Initial Conclusions

• There is no indication that any one division is going to do much better or worse than it has done in the past.

• Absent some indication from management that major changes are afoot it seems likely that the past SLE numbers will be fairly reflective of the future SLE numbers.– One caveat, given the bad news in the

footnotes, we might even expect to see some deterioration in the future numbers.

What Management Says

• ... net sales for the fourth quarter of fiscal 2004, ending July 3, 2004, were $5.1 billion, up 11% compared to $4.6 billion in the prior year’s fourth quarter.

• Diluted earnings per share (EPS) were $.44 for the fourth quarter, an increase of 19% compared to $.37 for last year’s fourth quarter.

• For fiscal 2004, sales were $19.6 billion, up 7% over fiscal 2003.

• Diluted EPS for the full year were $1.59, compared to $1.50 in fiscal 2003, an increase of 6%.

Sara Lee press release 8/5/2004.

Press Release and Conference Call

• The company cut long term EPS growth guidance to 5-8% from 8-10%.

• For FY04 EPS was $1.59 for a 53 week year. Equivalent to a EPS of 1.56 for a 52 week year.

• For FY05 indicated EPS would range from $1.61-1.71.– Implied growth of 1% to 9.6%.– Current inflation rate 3.3%.

• Unless earnings growth comes in at the high end of management’s projections:– Meeting management’s long term growth projection will require

substantially improved EPS growth in the intermediate future.– Need to make up for anemic near term growth.

Firm’s Current Plans(from conference call)

• Reduce costs– Closing plants.– Cutting breadth of the product line.

• In FY 2001 sold Coach Leather Products.– Since Coach was sold its stock has risen 535% since

10/2000. – Wilshire 5000 in the same period is down 22%.

• Undo the Above?– Adding trendy diet products (my

interpretation).

SLE Costs(More from the Conference Call)

• Cotton and other commodity costs are up.• Haynes underwear brand is under a lot of

price pressure.– Management will try to boost sales via

increased advertising.– At the very least apparel profits seem unlikely

to improve.

• SLE corporate tax rate is up and the firm projects that it will continue to rise.

Lesson

• Conference calls are important!

• You can find them on company web pages.

• Listen to them.

Lesson from the Coach Sale

• When Coach is let loose from SLE it produces profits well above market expectations.– Implies profitability was held back by having

SLE run Coach.– Certainly does not lead to confidence in SLE

management.

Conclusions for Projections

• Firm seems to be fairly stagnant. Overall, not showing any particular areas of accelerating growth or collapse.

• Absent evidence to the contrary I will assume past results are indicative of future results.

• Until recently management was using free cash flow to buy down debt, and may continue to do so in the future. (From conference call.) I am going to assume the dollar amount of debt will remains constant going forward.

Income Statement

52 Wks 52 Wks 52 Wks 52 Wks 53 Wks

1-Jul-00 30-Jun-01 29-Jun-02 28-Jun-03 3-Jul-04

Net Sales 16,454 16,632 17,628 18,291 19,566

Total Revenue 16,454 16,632 17,628 18,291 19,566

Cost of Sales 10,124 10,417 10,829 11,052 12,017

Cost of Sales/Exit 0 26 -7 0 NA

SG&A. 4,587 4,597 5,236 5,568 5,897

Sale/Coach 0 -967 0 0 NA

Sale of Business 0 528 177 -11 48

Contingent Sale Proceeds NA NA NA 0 -119

Int. Expense 252 270 304 276 271

Int. Inc. -76 -90 -96 -78 -90

Product Recall 0 0 NA NA NA

Restruct. Chrg. 0 NA NA NA NA

Total Operating Expense 14,887 14,781 16,443 16,807 18,024

Net Income Before Taxes 1,567 1,851 1,185 1,484 1,542

Provision for Income Taxes 409 248 175 263 270

Net Income After Taxes 1,158.00 1,603.00 1,010.00 1,221 1,272

Net Income Before Extra. Items 1,158 1,603 1,010 1,221 1,272

Discont. Ops. 64 663 0 0 NA

Accounting Change 0 NA NA NA NA

Net Income 1,222 2,266 1,010 1,221 1,272

Income Statement

3-Jul-99 1-Jul-00 30-Jun-01 29-Jun-02 28-Jun-03

Cash & Equiv. 279 314 548 298 942

Rcvbl., Gross 1,804 1,959 1,695 2,007 2,109

Doubtful Account -193 -195 -157 -176 -181

Finished Goods 1,602 1,941 1,715 1,619 1,810

Work in Process 470 529 454 411 405

Materials/Suppl. 463 481 413 479 489

Other 294 382 321 341 378

Business Sale 315 563 94 7 1

Total Current Assets 5,034 5,974 5,083 4,986 5,953

Balance Sheet

Other 326 465 264 192 284

Land 94 99 98 176 202

Build./Improv. 1,613 1,745 1,646 1,744 1,915

Mach./Equip. 2,756 3,188 2,891 4,299 4,917

Const. In Prog. 260 330 266 320 291

Depreciation -2,699 -3,043 -2,755 -3,384 -3,975

Trademarks 1,022 1,095 1,145 2,106 2,110

Goodwill 1,886 1,758 1,529 3,314 3,387

Total Assets 10,292 11,611 10,167 13,753 15,084

Balance Sheet

Notes Payable 1,116 2,054 101 468 75

Accounts Payable 1,645 1,762 1,505 1,321 1,286

Payroll/Benefits 779 928 812 1,147 1,195

Advertising 386 421 343 469 501

Other Taxes 89 104 84 102 112

Accrued Taxes 45 55 423 122 11

Other 1,320 1,054 1,210 1,100 1,015

Cur.Port.LT Debt 336 381 480 734 1,004

Total Current Liabilities 5,716 6,759 4,958 5,463 5,199

Long Term Debt 1,892 2,248 2,640 4,357 5,157

Total Long Term Debt 1,892 2,248 2,640 4,357 5,157

Balance Sheet

Deferred Tax 71 148 244 534 200

Pension Oblig. NA NA 38 220 1,178

Other Liabs. 701 581 525 787 901

Minority Int. 613 616 625 632 358

Total Liabilities 8,993 10,352 9,030 11,993 12,993

Balance Sheet

Pref. Stock 0 NA NA NA NA

ESOP Convertible 265 252 238 226 221

Deferred Comp. -232 -227 -223 -208 -182

Common Stock 9 8 8 8 8

Paid In Capital 508 0 0 59 1

Retained Erngs. 1,760 2,393 2,635 3,168 3,787

Comp. Income -1,006 -1,146 -1,521 -1,470 -1,734

Unearned Stock NA NA NA -23 -10

Restricted Stock -5 -21 0 NA NA

Ttl. Equity 1,299 1,259 1,137 1,760 2,091

Ttl. Liabilities & Shareholders' Equity 10,292 11,611 10,167 13,753 15,084

S/O-Common Stock 883.8 846.3 782 784.7 777.3

Ttl. Com. Shares Out. 883.8 846.3 782 784.7 777.3

Employees 138,000 154,000 141,500 154,900 145,800

# of Com. Shareholders 83,300 82,600 78,400 74,500 95,078

Balance Sheet



Net Income 1,131 1,158 1,603 1,010 1,221

Depreciation 352 402 392 471 532

Amort. Intang. 181 200 207 111 142

Sale/Coach NA NA -967 0 0

Sale of Business -137 0 554 101 -16

Product Recall 76 0 0 NA NA

Restruct. Charge 0 0 NA NA NA

Cash Flow Statement



Deferred Inc. Tax 29 48 88 21 -48

Non-$ Charges -35 -38 -62 7 40

Accounts Rec. -21 -116 42 93 86

Inventories 112 -152 25 304 -22

Current Assets -60 -47 -11 7 -10

Accounts Pay. -50 -56 -133 -417 -131

Accrued Liabil. -29 57 -218 27 30

Discont. Ops. 54 84 -24 0 0

$ from Operating Activities 1,603 1,540 1,496 1,735 1,824

Cash Flow Statement



Cap. Ex. -535 -647 -532 -669 -746

Acq. of Business -234 -743 -300 -1,930 -10

Disposition of Bus. 412 21 1,819 23 0

Sale of Property 158 64 65 113 81

Other, Net 7 9 13 -12 1

$ from Investing Activities -192 -1,296 1,065 -2,475 -674

Cash Flow Statement

Preferred Stock, Net 0 NA NA NA NA

Iss. Common Stock 111 84 104 109 98

Purch. Common Stock -1,279 -1,032 -643 -138 -305

Rdmpt. of Preferred NA NA 0 0 -250

Iss. Equity Sec. 50 0 NA NA NA

Borrowings LT Debt 20 725 1,023 1,362 1,773

Repay. LT Debt -284 -502 -390 -503 -995

ST Borrowings 451 1,022 -1,914 124 -395

Dividend Paid -464 -485 -486 -484 -497

$ from Financing Activ. -1,395 -188 -2,306 470 -571

FX Effects -10 -21 -21 20 65

Net Change in Cash 6 35 234 -250 644

Cash Interest Paid 242 249 251 293 302

Cash Taxes Paid 321 245 259 266 265

Net $ - Beg. Balance 273 279 314 548 298

Net $ - Ending Balance 279 314 548 298 942

Cash Flow Statement

Sara Lee Free Cash Flow ModelIncome Statement

• EBIT– Information found on the Income Statement– Net Sales – Cost of Sales – SG&A – Sale of

Business• Sale of Business is “optional.” Depends on if you

think this is a very unusual item.– My view, put it in at first. If it really is “unusual” that will

show up in the FCF figure and you can undo it later.

• Tax Rate I = 1- Net Income After Taxes/Net Income Before Taxes.

SLE FCF Model



EBIT 1,743.00 2,057.00 1,386.00 1,682.00 1,604.00

Cash Flow Statement

• EBITDA– EBIT + Depreciation + Amortization.– Find these on the cash flow statement.

• Net Capital Expenditures– Property Plant and Equipment (PP&E) + Sale of

Property (Assets).• Can leave out Sale of Property if you do not think they are

asset sales.

• Change in Working Capital– ΔWC = Accounts Receivable + Accounts Payable +

Inventories.

SLE FCF Model



EBIT 1,743 2,057 1,386 1,682 1,604

EBITDA 2,276 2,659 1,985 2,264 2,278

NetCapEx -377 -583 -467 -556 -665

ΔWC 41 -324 -66 -20 -67

Balance Sheet

• Total Debt– Total Debt + Current Portion of Long Term Debt + Notes

Payable• Current Portion of Long Term Debt represents long term debt

instruments due in one year or less.• Notes Payable represents short term debt.

– Some people do not include Notes Payable. If you do drop them then you need to drop the interest paid on them as well.

• Debt Interest Rate = Cash Interest Paid/Total Debt– Cash Interest Paid from the Cash Flow Statement– Debt is reported year end. Want average outstanding debt.

Average year end with year end.• Example: Average debt for SLE year end 30-Jun-01 equals:

– (Total Debt from year end 1-Jul-00 + Total Debt from year end 30-Jun-01)/2

– which is (3,344+4683)/2.

SLE FCF Model



EBIT 1,743 2,057 1,386 1,682 1,604

EBITDA 2,276 2,659 1,985 2,264 2,278

NetCapEx -377 -583 -467 -556 -665

ΔWC 41 -324 -66 -20 -67

Cash Int. 242 249 251 293 302

Total Debt 3,344 4,683 3,221 5,559 6,236

% Rate 7.24% 6.20% 6.35% 6.67% 5.12%

Items from Multiple Statements

• Free Cash Flow Before Taxes = EBITDA + Net Cap. Ex. + ΔWC – Cash Interest Paid.

• Free Cash Flow = EBITDA + Net Cap. Ex. + ΔWC – Cash Taxes Paid – Cash Interest Paid

• Cash Interest Paid from the Cash Flow Statement.

• Tax Rate II = Cash Taxes Paid/FCF Before Taxes.

SLE FCF Model52 Wks 52 Wks 52 Wks 52 Wks 53 Wks


EBIT 1,743 2,057 1,386 1,682 1,604

EBITDA 2,276 2,659 1,985 2,264 2,278

NetCapEx -377 -583 -467 -556 -665

ΔWC 41 -324 -66 -20 -67

Cash Int. 242 249 251 293 302

Total Debt 3,344 4,683 3,221 5,559 6,236

% Rate 7.24% 6.20% 6.35% 6.67% 5.12%

Cash Tax 321 245 259 266 265

Tax Rate I 26.10% 13.40% 14.77% 17.72% 17.51%

Avg. TR I 17.90%

FCF 1,377 1,258 942 1,129 979

SLE FCF Model52 Wks 52 Wks 52 Wks 52 Wks 53 Wks


EBITDA 2,276 2,659 1,985 2,264 2,278

NetCapEx -377 -583 -467 -556 -665

ΔWC 41 -324 -66 -20 -67

Cash Int. 242 249 251 293 302

Cash Tax 321 245 259 266 265

Tax Rate I 26.10% 13.40% 14.77% 17.72% 17.51%

Avg. TR I 17.90%

FCF BT 1165 901 602 813 570

FCF 1,377 1,258 942 1,129 979

Tax Rate II 27.55% 27.19% 43.02% 32.72% 46.49%

Avg. TR II 35.40%

Stock Pricing

• All Equity FCF = FCF – Tax Rate×Cash Interest Paid.



FCF 1,377 1,258 942 1,129 979

All Equity FCF TR I 1,313 1,224 904 1,077 926

All Equity FCF TR II 1,291 1,169 853 1,025 872

Note: TR I uses TR as calculated for the year. TR II uses the average tax rate calculated over five years (35.40%).

Some Finance at Last!

• What is rE?– Yahoo has the equity beta listed as .35. That is just not

believable.– Consumer products may be less volatile than the market, but not

by much.– Very low and very high betas are more likely than not due to

measurement error.– Running regression of rSLE-rf = α+β(rm-rf) over the last five years

yields an even lower estimate of .03!– Time to give up and use 1.– Assuming rf = 2.1% per annum (as reported on the St. Louis

Federal Reserve web page), and the market risk premium equals its historical average of 8% this yields rE of 10.1%.

WACC• Debt-Equity Ratio

– Get total equity value from CRSP.– Get total debt from earlier calculation.


Total Debt 3,344 4,683 3,221 5,559 6,236

Equity Mkt. Cap 16,342 14,810 16,196 14,621 18,169

D/E 0.205 0.316 0.199 0.380 0.343

• Debt increasing at about 10% per year.

• D/E increasing modestly.

• SLE has been buying other companies.

• Tax rate: Will use both TR I and TR II averages and see what happens.

WACC Continued• Using WACC formula year by year:


Total Debt 3,344 4,683 3,221 5,559 6,236

Equity Mkt. Cap 16,342 14,810 16,196 14,621 18,169

D/E 0.205 0.316 0.199 0.380 0.343

% Rate 7.24% 6.20% 6.35% 6.67% 5.12%

WACC TR I 9.29% 8.96% 9.32% 8.83% 8.60%

WACC TR II 9.18% 8.64% 9.11% 8.51% 8.36%

• Declining somewhat. Mostly from lower debt rates.• Lack of trend, plus increasing D/E implies a WACC of

8.60% or 8.36%. Both are probably too low. Try them for now.

Stock Value Using WACC

• Set growth rate to 1%.– Seems too high given earlier discussion.– Using All Equity FCF from TR I of 927.– PV = 926/(.0860-.01) = 12,187.– Total shares outstanding = 790.– Price per share = 12,194/790 = $15.42– With TR II: PV = 872/(.0836-.01) = 11,841.– Price per share = $14.98.– Current share price (8/23) = 21.96.

Stock Value Using APV

• PV AEFCF with 1% growth:– 926/(.101-.01) = 10,177.

• Debt Tax Shield With TR I– Debt payments have been growing slowly.– Start with 305 and no additional growth.– DTS = 305×.1790/.0512 = 1,066.

• Enterprise Value = 10,177 + 1,066 = 11,243.• Equity = 11,243 – 6,236 = 5,007.• Stock Price = 5,007/790 = $6.34

APV with TR II

• Enough already!

• Use TR II as an exercise for your own use.

• I get a price per share of $6.90.

Modifying the APV Model

• Perhaps the debt tax shield is too low.

• Debt has been growing.– Can expect tax shield to grow too.

• Assume debt tax shield grows at 1% per year. Same as the firm’s FCF.

• DTS = 305×.1790/(.0512-.01) = 1,324

• Stock Price = $6.66

APV with Even Faster Debt Growth?

• Debt cannot grow faster than the firm forever.– If it does eventually the firm will be all debt financed

and the debt will be forced to grow at the same rate as the firm.

• Alternative is to grow the debt at a faster rate than the firm for X years and then drop it down.

• If this happens will the debt discount rate remain the same?– Unlikely. Need to adjust that to account for the lower

quality debt.– In the end realistic scenarios are unlikely to greatly

modify SLE’s value by enough to bring the model’s value up to the current stock price.

Lesson

• If your model says the stock price is too high.– And your model already has assumptions that

you believe overstate the firm’s value.– Quit working and declare victory!

• Converse holds if your model says the stock price is too low.– If you believe the assumptions already

understate the firm’s value, quit modeling!

Things to Do

• Robustness checks.– Assumed a measly 1% growth rate. What if

management is right and growth comes in at 8%?

– Assumed a beta of 1 when discounting. What if you assume a somewhat lower value like .8?

• Is there really good evidence it should be .8, or 1 or even 1.2?

More to Do

• Division level analysis.– Clothing has been relatively profitable, but

management seem to be warning that may not continue.

– Management may close a number of marginally profitable food operations. What will that do?

valuation example sara lee (sle). what does sle do? food –meats to large intermediaries such as...

Documents

total sales

business segments sales

operating results

total net sales

intersegment sales

overall sales

amortization of intangibles

business process