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Valuation Example Sara Lee (SLE). What Does SLE Do? Food –Meats to large intermediaries such as supermarkets, and foodservice distributors. –Bakery to.

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Presentation on theme: "Valuation Example Sara Lee (SLE). What Does SLE Do? Food –Meats to large intermediaries such as supermarkets, and foodservice distributors. –Bakery to."— Presentation transcript:

1 Valuation Example Sara Lee (SLE)

2 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.

3 Operating Results by Business Segment—2003 Compared With 2002 Operating results by business segment for 2003 compared with 2002 are as follows: Sales Operating Segment Income2003200220032002 Sales Operating Segment Income 2003200220032002 Sara Lee Meats 3,7463,704375323 Sara Lee Bakery 3,2762,9769897 Beverage 2,7562,539429416 Household Products 2,1181,962369339 Intimates and Underwear 6,3996,455763596 Total business segments 18,29517,6362,0341,771 Intersegment sales (4)(8)— — Total sales and operating segment income 18,29117,6282,0341,771 Amortization of intangibles — — (104)(77) General corporate expenses — — (248)(301) Total net sales and operating income 18,29117,6281,6821,393 Net interest expense — — (198)(208) Net sales and income before income taxes 18,29117,6281,4841,185 A discussion of each business segment’s sales and operating segment income is presented below. 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. 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.

4 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?

5 Relative Contribution by Division Operating Income/Sales before Depreciation Fraction of Operating Income 2003200220032002 Sara Lee Meats0.100.090.18 Sara Lee Bakery0.03 0.05 Beverage0.16 0.210.23 Household Products0.17 0.180.19 Intimates and Underwear0.120.090.380.34 Total business segments0.110.101.00

6 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.

7 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.

8 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.

9 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.

10 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).

11 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.

12 Lesson Conference calls are important! You can find them on company web pages. Listen to them.

13 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.

14 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.

15 Income Statement 52 Wks 53 Wks 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 Net Sales16,45416,63217,62818,29119,566 Total Revenue16,45416,63217,62818,29119,566 Cost of Sales10,12410,41710,82911,05212,017 Cost of Sales/Exit026-70NA SG&A.4,5874,5975,2365,5685,897 Sale/Coach0-96700NA Sale of Business0528177-1148 Contingent Sale ProceedsNA 0-119 Int. Expense252270304276271 Int. Inc.-76-90-96-78-90 Product Recall00NA Restruct. Chrg.0NA Total Operating Expense14,88714,78116,44316,80718,024

16 Net Income Before Taxes1,5671,8511,1851,4841,542 Provision for Income Taxes409248175263270 Net Income After Taxes1,158.001,603.001,010.001,2211,272 Net Income Before Extra. Items1,1581,6031,0101,2211,272 Discont. Ops.6466300NA Accounting Change0NA Net Income1,2222,2661,0101,2211,272 Income Statement

17 3-Jul-991-Jul-0030-Jun-0129-Jun-0228-Jun-03 Cash & Equiv.279314548298942 Rcvbl., Gross1,8041,9591,6952,0072,109 Doubtful Account-193-195-157-176-181 Finished Goods1,6021,9411,7151,6191,810 Work in Process470529454411405 Materials/Suppl.463481413479489 Other294382321341378 Business Sale3155639471 Total Current Assets5,0345,9745,0834,9865,953 Balance Sheet

18 Other326465264192284 Land949998176202 Build./Improv.1,6131,7451,6461,7441,915 Mach./Equip.2,7563,1882,8914,2994,917 Const. In Prog.260330266320291 Depreciation-2,699-3,043-2,755-3,384-3,975 Trademarks1,0221,0951,1452,1062,110 Goodwill1,8861,7581,5293,3143,387 Total Assets10,29211,61110,16713,75315,084 Balance Sheet

19 Notes Payable1,1162,05410146875 Accounts Payable1,6451,7621,5051,3211,286 Payroll/Benefits7799288121,1471,195 Advertising386421343469501 Other Taxes8910484102112 Accrued Taxes455542312211 Other1,3201,0541,2101,1001,015 Cur.Port.LT Debt3363814807341,004 Total Current Liabilities5,7166,7594,9585,4635,199 Long Term Debt1,8922,2482,6404,3575,157 Total Long Term Debt1,8922,2482,6404,3575,157 Balance Sheet

20 Deferred Tax71148244534200 Pension Oblig.NA 382201,178 Other Liabs.701581525787901 Minority Int.613616625632358 Total Liabilities8,99310,3529,03011,99312,993 Balance Sheet

21 Pref. Stock0NA ESOP Convertible265252238226221 Deferred Comp.-232-227-223-208-182 Common Stock98888 Paid In Capital50800591 Retained Erngs.1,7602,3932,6353,1683,787 Comp. Income-1,006-1,146-1,521-1,470-1,734 Unearned StockNA -23-10 Restricted Stock-5-210NA Ttl. Equity1,2991,2591,1371,7602,091 Ttl. Liabilities & Shareholders' Equity10,29211,61110,16713,75315,084 S/O-Common Stock883.8846.3782784.7777.3 Ttl. Com. Shares Out.883.8846.3782784.7777.3 Employees138,000154,000141,500154,900145,800 # of Com. Shareholders83,30082,60078,40074,50095,078 Balance Sheet

22 53 Wks52 Wks 3-Jul-991-Jul-0030-Jun-0129-Jun-0228-Jun-03 Net Income1,1311,1581,6031,0101,221 Depreciation352402392471532 Amort. Intang.181200207111142 Sale/CoachNA -96700 Sale of Business-1370554101-16 Product Recall7600NA Restruct. Charge00NA Cash Flow Statement

23 53 Wks52 Wks 3-Jul-991-Jul-0030-Jun-0129-Jun-0228-Jun-03 Deferred Inc. Tax29488821-48 Non-$ Charges-35-38-62740 Accounts Rec.-21-116429386 Inventories112-15225304-22 Current Assets-60-47-117-10 Accounts Pay.-50-56-133-417-131 Accrued Liabil.-2957-2182730 Discont. Ops.5484-2400 $ from Operating Activities1,6031,5401,4961,7351,824 Cash Flow Statement

24 53 Wks52 Wks 3-Jul-991-Jul-0030-Jun-0129-Jun-0228-Jun-03 Cap. Ex.-535-647-532-669-746 Acq. of Business-234-743-300-1,930-10 Disposition of Bus.412211,819230 Sale of Property158646511381 Other, Net7913-121 $ from Investing Activities-192-1,2961,065-2,475-674 Cash Flow Statement

25 Preferred Stock, Net0NA Iss. Common Stock1118410410998 Purch. Common Stock-1,279-1,032-643-138-305 Rdmpt. of PreferredNA 00-250 Iss. Equity Sec.500NA Borrowings LT Debt207251,0231,3621,773 Repay. LT Debt-284-502-390-503-995 ST Borrowings4511,022-1,914124-395 Dividend Paid-464-485-486-484-497 $ from Financing Activ.-1,395-188-2,306470-571 FX Effects-10-21 2065 Net Change in Cash635234-250644 Cash Interest Paid242249251293302 Cash Taxes Paid321245259266265 Net $ - Beg. Balance273279314548298 Net $ - Ending Balance279314548298942 Cash Flow Statement

26 Sara Lee Free Cash Flow Model Income 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.

27 SLE FCF Model 52 Wks 53 Wks 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 EBIT1,743.002,057.001,386.001,682.001,604.00

28 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.

29 SLE FCF Model 52 Wks 53 Wks 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 EBIT1,7432,0571,3861,6821,604 EBITDA2,2762,6591,9852,2642,278 NetCapEx-377-583-467-556-665 ΔWC41-324-66-20-67

30 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.

31 SLE FCF Model 52 Wks 53 Wks 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 EBIT1,7432,0571,3861,6821,604 EBITDA2,2762,6591,9852,2642,278 NetCapEx-377-583-467-556-665 ΔWC41-324-66-20-67 Cash Int.242249251293302 Total Debt3,3444,6833,2215,5596,236 % Rate7.24%6.20%6.35%6.67%5.12%

32 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.

33 SLE FCF Model 52 Wks 53 Wks 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 EBIT1,7432,0571,3861,6821,604 EBITDA2,2762,6591,9852,2642,278 NetCapEx-377-583-467-556-665 ΔWC41-324-66-20-67 Cash Int.242249251293302 Total Debt3,3444,6833,2215,5596,236 % Rate7.24%6.20%6.35%6.67%5.12% Cash Tax321245259266265 Tax Rate I 26.10%13.40%14.77%17.72%17.51% Avg. TR I 17.90% FCF1,3771,2589421,129979

34 SLE FCF Model 52 Wks 53 Wks 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 EBITDA2,2762,6591,9852,2642,278 NetCapEx-377-583-467-556-665 ΔWC41-324-66-20-67 Cash Int.242249251293302 Cash Tax321245259266265 Tax Rate I 26.10%13.40%14.77%17.72%17.51% Avg. TR I 17.90% FCF BT1165901602813570 FCF1,3771,2589421,129979 Tax Rate II 27.55%27.19%43.02%32.72%46.49% Avg. TR II 35.40%

35 Stock Pricing All Equity FCF = FCF – Tax Rate×Cash Interest Paid. 52 Wks 53 Wks 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 FCF1,3771,2589421,129979 All Equity FCF TR I 1,3131,2249041,077926 All Equity FCF TR II 1,2911,1698531,025872 Note: TR I uses TR as calculated for the year. TR II uses the average tax rate calculated over five years (35.40%).

36 Some Finance at Last! What is r E ? –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 r SLE -r f = α+β(r m -r f ) over the last five years yields an even lower estimate of.03! –Time to give up and use 1. –Assuming r f = 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 r E of 10.1%.

37 WACC Debt-Equity Ratio –Get total equity value from CRSP. –Get total debt from earlier calculation. 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 Total Debt3,3444,6833,2215,5596,236 Equity Mkt. Cap16,34214,81016,19614,62118,169 D/E0.2050.3160.1990.3800.343 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.

38 WACC Continued Using WACC formula year by year: 1-Jul-0030-Jun-0129-Jun-0228-Jun-033-Jul-04 Total Debt3,3444,6833,2215,5596,236 Equity Mkt. Cap16,34214,81016,19614,62118,169 D/E0.2050.3160.1990.3800.343 % Rate7.24%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.

39 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.

40 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

41 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.

42 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

43 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.

44 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!

45 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?

46 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?


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