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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 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.
Operating Results by Business Segment—2003 Compared With 2002 Operating results by business segment for 2003 compared with 2002 are as follows: Sales OperatingSegment Income 2003 2002 2003 2002 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.
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?
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.
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.
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.
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.
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.
Stock Pricing • All Equity FCF = FCF – Tax Rate×Cash Interest Paid. 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. • 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: • 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?