In the third quarter, legendary investor George Soros acquired almost 540,000 shares of Sara Lee (NYSE:SLE). While it’s not a huge position, it does indicate Soros believes Sara Lee’s stock has some upside. Sara Lee stock is up about 7% year-to-date and 28% on an annual basis over the past three years. It’s a winner relative to the S&P 500. Another winner in processed foods is ConAgra Foods (NYSE:CAG), which is up 13% YTD and 18% annually over the same three years.
George Soros certainly isn’t wrong in owning Sara Lee. It’s just that ConAgra is a better buy, both in terms of valuation and the brands it owns.
When most people think of Sara Lee, the first thing that comes to mind is its frozen cakes and pies. At least that’s what I think of. Of course, the company is much more. Its brands are divided into three segments: bakery, beverage and meats. Come the first half of 2012, Sara Lee will spin off its international coffee and tea business, which is the growth vehicle of the existing Sara Lee organization. No name has been announced yet, but it’s expected the beverage business will operate out of Europe while the North American retail and North American food service and specialty meats businesses retain the “Sara Lee” name.
To give you an idea how important the coffee and tea business is to Sara Lee, consider its first-quarter report. Coffee and tea revenues accounted for 47% of the overall total, while the segment’s income before tax was 62% of the overall total. Revenues for coffee and tea grew 26.6% year-over-year in the first quarter to $922 million, while the other businesses grew just 2.2%. On the income side, pretax income for coffee and tea grew 26.7% in the quarter to $114 million, compared to a decline of 16.5% for the other Sara Lee businesses. And the company has been focused of late on expanding the business, with Monday’s announcement of a buyout of the Dutch Coffee Company and November’s purchase of House of Coffee.
As an enticement for existing and potential Sara Lee shareholders, the company will pay a $3 special dividend prior to the completion of the spinoff. At current prices, that’s an additional yield of 15%. Why is it making such a grand gesture? You would hope it’s to reward long-time shareholders, but I suspect it’s being done to put a floor under the price of its stock. Like Kraft‘s (NYSE:KFT) spinoff, this move signals the fact its North American businesses possess very little growth potential.
Now let’s think about ConAgra. I can surely recognize far more of its brands than I can Sara Lee’s. I routinely use Hunt’s diced tomatoes, Pam cooking spray and Orville Redenbacher’s popcorn. Like Sara Lee, it also has a food service business. Unlike Sara Lee, it’s quite an important part of the overall business, delivering 38% of the revenues in the first quarter ended Aug. 28 and 33% of the operating profits. Furthermore, its commercial foods division grew revenues 18.9% in the quarter compared to 4.4% for the consumer foods segment.
The only negative in the quarter — from a numbers perspective — is both segments saw lower profits in Q1, including a 13.8% decline in commercial foods. However, in 2012, ConAgra expects to grow earnings per share in the low-to-mid-single-digits, which is plenty.
At the end of the day, ConAgra is a better company. Here are five quick reasons I believe this to be the case:
- ConAgra’a operating margins are consistently higher than Sara Lee’s.
- ConAgra’s enterprise value is 7.6 times EBITDA, almost 30% less than Sara Lee.
- ConAgra’s dividend yield is 3.8% versus 2.4% for Sara Lee.
- ConAgra’s brands are superior. The recent acquisition of the National Pretzel Co. just makes them stronger.
- ConAgra hired Andrew George Ross on Nov. 15 as its chief strategy officer. With significant strategic planning experience, it’s clear the company is serious about its growth ambitions.
Bottom Line
There’s no doubt Sara Lee’s $3 special dividend is enticing. However, if you take that out of the equation, Sara Lee’s spinoff isn’t nearly as interesting. Neither is its business.
As of this writing, Will Ashworth did not own a position in any of the aforementioned stocks.
