Barron’s gave a very positive write-up over the weekend on shares of Sara Lee (SLE), effectively saying that SLE shares could run up 40% or more after its push into healthier products. 

Barron’s highlighted the company’s new CEO’s efforts to go into healthier products and has noted cost-cutting and non-core business sales. The article sites an investor and former hedge fund portfolio manager named James Lane as almost the whole thesis for this article, calling for the company to be more focused on its core brands or for the company to be a part of a larger company. This 40% figure was also given by the same private investor talking about a mere 13-times earning multiple for this year’s expected earnings before throwing out an implied share target of $16.50.  Lane was further noting that the J.M. Smucker deal for Folgers could mean the value of the company could be 50% higher than its enterprise value.

A second analyst from a research firm called Mintel was noted by Barron’s commenting about Sara Lee’s Ball Park Franks winning over Kraft (KFT) hot dog sales and about its lunchmeat business winning more share as well at a time when the company is going healthier with 20% less salt in products over the next five years.

Also noted is a 3.6% dividend yield and the notion that Sara Lee may buy back shares after it announced a $1 billion share buyback in September when it sold its body care business for $1.9 billion. 

The one issue that is a wild card here, which was also brought up by Barron’s, is the issue of a possible takeover. It seems that the Kraft buyout of Cadbury (CBY) having such a premium is part of the reasoning, and it has been hard to ignore that Warren Buffett of Berkshire Hathaway (BRKB), as Kraft’s single largest shareholder, called this an expensive deal even before Kraft raised its price. We’d also caution that the Smucker deal with Procter & Gamble (PG) was in 2008 and was an all-stock deal and only included an added $350 million in debt assumption.

The food and candy sector has seen consolidation, and many expect this consolidation to continue this year and next. Just keep in mind that many have hoped that Sara Lee would be a takeover target all the way back into the 1990s. A buyout from a consolidation angle is about the way we see this much near-term upside of anywhere close to 40% today.

The growth of the company’s share price may depend more upon the use of the new cash, via its ability to reduce its share float and then ultimately for debt retirement and potentially larger dividends. Its balance sheet has been leveraged, although we admit that seems to be getting less leveraged today. A much larger player could absorb the leverage for little more than a financial footnote to the financial statements, but that is not the same case for mid-tier food and candy companies.

We would also like to point out that the entire analyst field from Thomson Reuters has a mean target and median price target of roughly $12.00 with an absolute high target of $15.00. It is true as Barron’s noted in its article that most analysts are cautious on the stock. We think there is a reason for that. The company’s move to a healthier fare is a simple one. It seems that ALL food companies have been trending this way considering how food in the U.S. has been under fire for years for making America obese. The reality is that no matter how you cut it, there is just not going to be very much healthy for weight loss and weight management in companies which sell pre-packaged, highly processed store-bought sweet treats, hot dogs, ice creams and bakery products.

After today’s gain of 2%, the market cap for the stock is over $8.3 billion. Sara Lee’s 3.6% dividend yield is actually the highest in the sector, and the company does have plenty of dividend coverage with estimates from Thomson Reuters being $0.95 for fiscal June 2010. The company might have to pay down more debt before it significantly raises its dividend. The 52-week trading range is $6.80 to $12.61, although this was a $20 stock five years ago. Technically, this stock has been dead money for the last decade. 

We’d also note that this one investor is more bullish than any of the analysts covering Sara Lee. A new world value of $15.00 might require significant earnings outperformance, and that would also seem to require a continued bull market rather than a choppy market that is finally starting to sell stocks even on good earnings and on good guidance. But a move above that in the next year would seem difficult to get to unless the company can lower costs and quietly pass on price hikes that are not a part of current estimates and that have historically been difficult to pass on to consumers. Grocery stores already run at very tight margins, and we have yet to see any fresh price hikes in the sector, so this seems unlikely today. 

There may still be some upside to Sara Lee. But a lot has to continue going the right way, and a lot of outside events would need to come about for this 40% upside to be seen in short order. If this article had come out before the above-mentioned events were known, then that 40% upside would be easier to buy into. We wouldn’t run out to short sell this stock endlessly, but we’d be far less optimistic than calling for an additional 40% move just based on one investor’s opportunity to talk up a stock. 

Tell us what you think here.

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