Food and beverage company Sara Lee‘s (NYSE:SLE) is due to announce its Q3 results this Thursday. Last quarter, the company’s core meat business showed a marked improvement in volume and mix trends in the U.S. and the coffee and tea beverage segment performed well in its key European markets. The company will soon spin-off into two separate, pure-play International Beverage and North American Meat companies. Despite an envious portfolio of market leading meat and beverages brands such as Jimmy Dean, it has been under-performing and trailing peers in terms of profitability over the last few years. It competes with major food and consumer companies like Kraft Foods (NYSE:KFT) and Nestle (NYSE:NESN).
Several of Sara Lee’s non-core businesses have weighed on the company’s profitability, particularly leading to inefficient supply-chain management. The company has lately been shedding them, trying to streamline the supply chain and rationalize operating expenses to improve returns. It has already divested its bakery, refrigerated dough and foodservice-focused tea & coffee businesses in North America. By splitting into two, the company hopes to better market its core meat and international beverages businesses, go for acquisitions to improve the market share and unlock cost synergies. The spun-off entities could also emerge as attractive takeover targets for other food and beverage players.
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Meat Business Improving as Food Service Slowly Recovers
The meats business volume decline slowed down last quarter, led by 4% growth in foodservice segment, selective pricing and improved mix. The consumer food service industry was hit very hard during the recession as a great number of consumers chose to eat at home rather than spend money to eat out. Continued macro-economic uncertainty, high commodity costs, unemployment and low consumer confidence have so far suppressed full recovery of the food services segment, particularly full-service restaurants. We expect gradual recovery in foodservice sector to help improve Sara Lee’s sales in North America.
International Beverage Continues To Grow
International coffee and tea segments have continued its strong performance in Western Europe with double digit sales growth, driven by pricing and strong mix. The business has recently been trying to expand its footprint across Europe and Latin America with the acquisitions of CoffeeCompany and House of Coffee in Europe and Expresso.Coffee and Café Damasco in Brazil and the launch of richer variants of Sanseo’s espresso-type products.
Margins Under Pressure
The company has experienced significant input cost volatility in 2011 and expects commodity costs to continue to increase and suppress gross margins in 2012, offset by cost-cutting efforts and higher pricing. Given that the company targets gross margins up to 36% by 2013-14 (from 32.4% in 2011), we will watch out for its cost performance and impact of its pricing efforts; although we expect the company to realize maximum cost-efficiency as it completes business reorganization later in the year.
We have a $22.69 Trefis price estimate for Sara Lee, at 3% premium to the current market price.