Sara Lee Equity Analysis and Valuation
Valued at 1 April 1, 2007
Analysts:
Todd L. Ehlers: todd.ehlers@ttu.edu
Michael D. Estes: mikestes@sbcglobal.net
Daniel W. Taylor: dtaylor1184@yahoo.com
Joseph R. Torres: rhyno1112@sbcglobal.net
Table of Contents
Page Number
Executive Summary……………………………………………………………………………………………… 2
Analysis Snapshot............................................................................................ 2
Company and Industry Overview…………………………………………………………………… 3
Accounting Analysis………………………………………………………………………………………. 3
Financial Ratio Analysis…………………………………………………………………………………. 4
Analysts Evaluations……………………………………………………………………………………… 4
Overview of Firm and Industry............................................................................... 5
Industry Overview and Analysis………………………………………………………………………….. 8
Rivalry Among Existing Firms………………………………………………………………………….8
Threat of New Entrants…………………………………………………………………………………. 15
Threat of Substitute Products………………………………………………………………………… 17
Bargaining Power of Buyers…………………………………………………………………………… 18
Bargaining Power of Suppliers……………………………………………………………………….. 20
Characterization of Industry……………………………………………………………………………20
Value Chain Analysis: Key Success Factors…………………………………………………………. 21
Competitive Advantage Analysis…………………………………………………………………………. 23
Cost Leadership……………………………………………………………………………………………. 24
Differentiation……………………………………………………………………………………………….27
Accounting Analysis……………………………………………………………………………………………… 30
Key Accounting Policies…………………………………………………………………………………. 30
Accounting Flexibility……………………………………………………………………………………..33
Accounting Strategies…………………………………………………………………………………… 36
Quality of Disclosure…………………………………………………………………………………….. 41
Manipulation Diagnostics………………………………………………………………………………. 43
Potential Red Flags………………………………………………………………………………………. 49
Undo Accounting Distortions…………………………………………………………………………..51
Ratio Analysis and Forecast Financials………………………………………………………………… 51
Time Series Analysis/Cross-Sectional Ratios……………………………………………………. 52
Liquidity Ratios…………………………………………………………………………………………….. 52
Profitability Ratios………………………………………………………………………………………… 66
Capital Structure Ratios………………………………………………………………………………… 78
SGR and IGR Analysis…………………………………………………………………………………… 83
Forecast of Financial Statements……………………………………………………………………. 85
Cost of Capital………………………………………………………………………………………………………. 92
Valuations…………………………………………………………………………………………………………….. 95
Method of Comparables………………………………………………………………………………… 96
Discounted Dividends Model………………………………………………………………………….. 100
Discounted Free Cash Flow Model………………………………………………………………….. 101
Residual Income Model…………………………………………………………………………………. 102
Abnormal Earnings Growth Model………………………………………………………………….. 103
Long Run ROE……………………………………………………………………………………………… 105
Credit Risk Analysis……………………………………………………………………………………………… 106
Analyst Recommendation……………………………………………………………………………………..107
Appendix………………………………………………………………………………………………………………. 109
References……………………………………………………………………………………………………………. 132
1
Executive Summary
Investment Recommendation: Overvalued, Sell
SLE- NYSE
$16.92
52 Week Range
$14.35 - $18.69
Revenue (2006)
$15.9 Bil.
Market Capitalization
$12.96 Bil.
Shares Outstanding
766,000,000
Dividend Yield
2.40%
3-Month Avg. Daily Trading Volume 3,654,200
Percent Institutional Ownership 69%
Book Value Per Share (mrq) $3.22
ROE 22.7%
ROA 3.8%
Estimated 5-yr EPS Growth Rate 4.0%
EPS Forecast
EPS
4/1/2007
2006(A) 2007(E) 2008(E) 2009(E)
$0.72
$1.10
$1.14
$1.19
Method of Comparables
Trailing P/E
Forward P/E
PEG
P/B
P/S
D/P
SLE
$21.59
$22.25
$23.18
$4.98
$0.77
$0.49
Industry
$15.63
$18.09
$19.28
$2.63
$1.70
$0.27
Valuation Estimates
Cost of Capital Est.
Ke Estimated
10-year
7-year
5-year
1-year
3-month
Kd
WACC
Altman Z-score
Beta
R^2
.652
.648
.650
.655
.655
.183
.181
.182
.1845
.1846
5.53%
6.07%
2.327
Ke
8.49%
9.64%
7.63%
7.66%
8.29%
8.49%
Actual Current Price
$16.92
Ratio Based Valuations
P/E Trailing
P/E Forward
PEG Forward
P/B
P/S
D/P
Enterprise Value
$14.22
$13.02
$13.32
$8.47
$35.38
$2.93
$29.77
Intrinsic Based Valuations
Discounted Dividends
Free Cash Flows
Residual Income
Abnormal Earnings Growth
Long-Run Residual Income Perpetuity
$11.24
$26.02
$9.44
$7.29
$10.27
2
Company and Industry Overview and Analysis
Sara Lee is a major player in the packaged and processed foods industry.
Sara Lee started in Baltimore in 1939 as the C. D. Kenny Company. It adopted
its current name in 1985, and they are now based in Chicago. Sara Lee makes
products from bread all the way to sausage. Other major competitors include
companies such as Pepsico, Kraft, General Mills, and Unilever. Sara Lee operates
within a highly competitive and mature industry that leaves little room for
extraordinary profits. Cost leadership is the number one factor in competition in
this highly competitive industry with possible small benefits to be gained from
differentiation strategies. On the other hand there is little threat from substitute
products given that food is always going to be a needed commodity. We feel
that this industry will under go few changes in the foreseeable future.
Accounting Analysis
The information that we used to base our report on was mostly found in
Sara Lee’s 10-k report and their annual reports. The 10-k contains a plethora of
information, and after careful review can provide the reader with a vast
knowledge of how a company performs its operations on a day-to-day basis.
The 10-k provides all of the financial statements and other pertinent accounting
information.
We have found that Sara Lee usually stays on the conservative side of
accounting procedures when drafting its various reports to be sent to the SEC
and general public. Sara Lee is also a very well disclosed company. Sara Lee
breaks down its information and gives the reader lots of insight into the
operations of the company. The extensiveness of the 10-k made the job of
analyzing the company more productive and effective.
3
Financial Ratio Analysis
By analyzing Sara Lee’s financial ratios we were able to get a better
understanding of how Sara Lee stands within its respective industry. Sara Lee’s
liquidity standing is fairly comparable to its competitors showing that it is able to
remain liquid while profitably conducting business. The only anomaly was from
inventory levels which appeared to be inefficient at times, but improvement is a
major focus of recent restructuring activities. Sara Lee’s low level of inventory
turnover results in lower percentage of working capital. This is showing that
cash is being held in inventory. The profitability analysis shows mostly negative
traits for Sara Lee in 2005 and 2006 with low profit margins, which are due to
higher expense ratios. Even with these negative signs Sara Lee has maintained
a higher return on equity than its competitors. We feel that Sara Lee will correct
recent problems and return to its recent performances after restructuring takes
effect. Sara Lee demonstrates a capital structure that is made up heavily of
debt. It maintained an average of approximately 4 to 1 for debt to equity for the
past 5 years. This has proven to be an effective strategy, though, since Sara Lee
has been able to earn more than its cost of debt, which is shown again by a high
return on equity.
Analysis Evaluations
We used several different valuation models to determine whether Sara
Lee was fairly valued or not. The different models that we used were the
discounted dividends model, discounted free cash flows model, residual income
model, abnormal earnings growth model, long run ROE perpetuity, and method
of comparables. After careful evaluation of each model we arrive to the
conclusion that Sara Lee is overvalued. We believe the stock price per share
should be around $9.44. The residual income model gave us the best estimate
4
of value. Sara Lee’s current share price is $16.92, so Sara Lee is, in our opinion,
greatly overvalued and a sell opportunity.
Overview of Firm and Industry
Sara Lee Corporation is one of the largest global manufacturers of brand
name consumer products around the world. Over the past several years, Sara
Lee has been a major player in producing and providing customers with a
number of household and retail products. In 2006, Sara Lee disposed of a
number of their select businesses in order to help it focus on its key food,
beverage, and household product business (Sara Lee Corp 10-K). By doing this,
it allowed Sara Lee to organize the company into seven distinct business
segments: North American Retail Meats, International Beverage, International
Bakery, North American Retail Bakery, Foodservice Household and Body Care
and Branded Apparel. What is known today as Sara Lee Corporation was
originally organized in Baltimore, Maryland in 1939 as the C.D. Kenny Company,
and eventually adopted its current name in 1985. They currently hold many of
its main corporate offices in Chicago, Illinois and operate more than 440 facilities
and manufacturing plants across the United States, as well as internationally.
Sara Lee’s competitors include Unilever, General Mills Inc., Campbell Soup Co.,
ConAgra Food Inc., McCormick Co. Inc., and Kraft Foods Inc.
(yahoo.com/finance).
5
Sara Lee’s Sales Volume
Fiscal Year End: June
TTM = 12 Trailing Months
(MorningStar.com)
Sara Lee’s sales volume has increased steadily from 2002 to 2004, with a
slight decrease in sales in 2005 and 2006. This was mainly an effect of it selling
off a number of its companies, as well as a spin-off of one of its major American
and Asian apparel brands; HanesbrandsInc. Ending in year 2002, sales were
around 17.6 billion with a steady increase to around 19.5 billion in 2004. The
selling off of a large number of its companies dropped sales to around 15.9
billion over the next two years ending in 2006. Sara Lee’s market cap grew from
14.7 billion in 2002 to around 17.4 billion in 2004. Market cap has decreased
over the last two years to 12.84 billion in 2006; a 10% decrease. Sara Lee ranks
4th in market cap in the overall industry, with Unilever leading the industry with
a market cap of 76.49 billion.
6
Sara Lee continues to be a dominant competitor in the industry with a
positive change in sales growth of around 11% from 2002 to 2004. Net Sales for
the first quarter of fiscal 2007, ending September 30, 2006, were $2.9 billion,
which was an increase of 5% compared to $2.8 billion in the prior years first
quarter (MorningStar.com). Sara Lee’s stock price steadily rose from $18.74 to
$21.96 in 2002 to 2004, preceding a drop in price over the next two years;
$19.93 to $16.90 from 2005 to 2006. This could be a result of steadily reducing
its number of total assets while also increasing its total liabilities from 2003 to
2006. Sara Lee also issued an average dividend of around $0.164 each quarter
from 2002 to 2006. Starting in 2006 Sara Lee for the first time in over two years
was able to grow in all segments, helping it increase its sales in both of its North
American retail bakery and international beverage division by 8%. Sara Lee is a
highly diverse company that process and manufacturer a number of different
consumer based products, such as: meats, bakery goods, coffee and beverage
products, shoe care products, air freshener products, as well as body care
products. Because of this, Sara Lee is able to compete in a variety of markets,
where its drive is to lead the market as well as inspire repeat purchases on its
branded consumer packaged goods.
7
Industry Overview and Analysis: Five Forces
In order to analyze a firm properly an analyst must understand the factors
and forces that control the decisions made within the industry of the firm. The
five forces model contains items concerning competition and bargaining power.
The model can easily be seen by the chart below (Palepu).
Rivalry Among
Existing Firms
Threat of New
Entrants
High
Threat of Substitute
Products
Low
Low
Industry
Profitability
Low
Bargaining Power of
Buyers
High
Bargaining Power of
Suppliers
Low
Rivalry Among Existing Firms
The profitability of a firm often relies heavily on the profitability of firms it
competes with in its industry. Companies must always keep a close eye on their
competitors and watch how their competitors are doing business. They will
either compete aggressively or non-aggressively. The firms can compete on
price or other non-price strategies.
8
Industry Growth
Growth within an industry is always a concern for companies competing
against one another. If one company does not take advantage of possible
growth their competitor will. One of two characteristics can be used to describe
an industry in terms of growth. Either the industry is growing fast enough for
companies to freely expand or it grows slowly causing growth of a company to
be at the expense of another company. Sara Lee is a major competitor in the
processed and packaged goods industry. This market has many competitors
including around ten that make a great impact on the industry. Current
competitors of Sara Lee include companies such as Pepsico, Unilever, and
General Mills. Many of the main players in this industry stay between 10 and 15
billion dollars in market capitalization (far behind Pepsico and Unilever). Such
firms include Sara Lee. In order to insure its place among the top in its industry,
Sara Lee has developed a long-term transformation plan. This plan was
launched in February 2005. The company feels that this plan will give them
opportunity to ensure long-term growth. The plan as four key aspects: disposing
of unneeded businesses, reorganizing continuing operations, improving
operational efficiency, and to consolidate the North American and the European
operations to one central headquarter for each.
9
Assets
Assests (in millions)
60000
50000
Sara Lee
40000
Unilever
30000
Kraft
20000
Kellogs
10000
General Mills
0
2002 2003 2004 2005 2006
The graph above showing the asset levels of each major firm within the
industry gives a look at the amount of market share held by each one. Kraft and
Unilever hold approximately two and three times more assets respectively than
the other competitors shown. General Mills, Kellogs and Sara Lee have remained
at fairly equal rates from 2002 to 2006. The firm’s entire asset levels have
remained at consistent levels even with major differences in size within the
industry this shows a high level of industry competition with little chance for
growth.
10
Sales
Sales (in millions)
60000
50000
Sara Lee
40000
Unilever
30000
Kraft
20000
Kellogs
10000
General Mills
0
2002
2003
2004
2005
2006
The graph showing sales levels helps to further confirm the findings from
the asset chart. This indicates that sales are a steady trend within the industry.
The firms shown have little fluctuation over the 5 year period. This graph also
indicates that there is a strong correlation between the level of assets and the
level of sales. Asset turnover which shows the amount of sales dollars generated
by each dollar of assets seems to be at equal ratios further stressing high
competition levels and low ability to gain competitive advantages.
Sales Growth
Sales (in millions)
0.4
0.3
0.2
Sara Lee
Unilever
0.1
Kraft
0
Kellogs
General Mills
-0.1
-0.2
2002
2003
2004
2005
2006
The chart showing the sales growths of industry firms over the past 5
years also shows that sales growth in this industry is somewhat equal. In 2003
11
this trend varied somewhat with General Mills having an unusually high growth in
sales and Unilever also moderately higher than competitors. This trend again
varied in 2005 with Sara Lee and Unilever having steep declines in sale levels.
Another slight distortion in found in 2006 when Kellogs demonstrated a high
sales growth rate in comparison to the other firms. Even given these anomalies
the data overall indicates that sales growth is a somewhat common trend in the
packaged foods industry.
Overall, the processed and packaged goods industry is growing relatively
slow and we expect this trend will continue. Many of the companies are
reaching peaks in this well-saturated market. Companies like Sara Lee, can still
grow but only when they steal customers from their competitors. Company
strategies like the one described above can be used to gain a little ground
against giants such as Unilever.
Concentration
The concentration of a market is a key factor in how a company is able to
conduct business within its industry. High concentration results when there are
few companies in an industry, and low concentration results when there are
many companies in an industry. The difference in how these two industries
operate is significant. High concentration has far less competition and prices are
not near as significant as in low concentration. As mentioned before, Sara Lee
has many competitors. This means their industry has a low concentration. This
low concentration is represented in all of Sara Lee’s many product lines. As a
result, this low concentration forces companies in the processed and packaged
goods industry to compete heavily on price. Sara Lee and its counterparts alike
must keep constant watch on each other.
12
Market Share
100%
Market Share
80%
Sara Lee
60%
Unilever
40%
Kraft
20%
General Mills
Kellogs
0%
2002
2003
2004
2005
2006
Market shares represented in the graph above confirm the data found in
the other charts showing that this industry is a relatively stagnant one. Of the
firms shown above, Unilever has consistently been the dominant firm when it
comes to the share of the market that it holds. While firms such as Kellogs and
General Mills have low market shares with little or no variation.
Differentiation and Switching Costs
Differentiation is how a company can distinguish its products from the
competitor’s products. The more differentiation a company has the less direct
competition the company will face. In Sara Lee’s industry, product differentiation
proves difficult. For example, a company’s bread is put on the shelf next to a
wide assortment of other breads. Such breads include Mrs. Baird’s, Sunbeam,
Wonder, and Pepperidge Farm. When so many options are available price
becomes the only way for a company to differentiate itself from the rest of the
competitors.
Switching costs is the amount that it costs a consumer to switch from one
company to another company. High switching costs will keep consumers with a
13
particular company, while low switching costs allow the consumers to easily
switch from one company to another. This industry produces breads, meats,
beverages, household products, and body care products that can be bought at
any major retailer right alongside all of their competition. Switching costs for
consumers are zero. Again, just like differentiation, switching costs force
companies in this industry to make price their main competitive edge.
Exit Barriers
Exit barriers are simply what stand between a company and its ability to
leave a particular market. Companies may leave one particular market to pursue
other ventures that may be more profitable. The common trend among
companies in the processed and packaged goods industry is to have many
product lines. Sara Lee, for example, has products from meat all the way to
insecticides. Unilever, McCormick, and others in the industry are not different.
For a company like Sara Lee to completely change industries would be
impossible. Although, Sara Lee could and has exited from individual product
lines it carries. One major example of this is when Sara Lee spun off its branded
clothing division into a completely separate company. In a process that was
completed within the last year, Sara Lee spun off popular brands such as Hanes
and Wonderbra. .Therefore exit barriers in this industry are low and an exit or
transformation can be done with little resistance.
The processed and packaged good industry demonstrates a high level of
rivalry among the existing firms. With little industry growth and high competition
there is not much chance of a firm quickly gaining more market than what it
currently has. In order for a firm to maintain or grow its position it will have to
remain highly competitive. This information indicates that this industry is mature
and has little potential for abnormal profits or chance of high growth.
14
Threats of New Entrants
In any industry, companies must be aware of the threat of new entrants
joining its particular market. The more companies that join an industry will, on
some scale, threaten or even damage the existing company’s earnings. The
threat of new entrants exist when markets look easy and attractive to join, low
startup costs for companies, low switching costs for customers, and any
abnormal profits or earnings. In this specific industry of processed and packaged
goods, it is difficult for new companies to join because of the competitiveness,
the advantage of the first movers, and the relationships already established with
suppliers and distributors of existing companies.
Economies of Scale
For companies new to this industry, economies of scale are important to
determine what types of things they must invest in to try to gain market share
with existing firms. Firms in this industry have extremely large asset bases, like
Unilever with 45 billion in assets; this allows them to operate with economies of
scale and would be hard for an entering firm to achieve. Even smaller firms such
as Sara Lee and General Mills maintain assets valued at 14 billion and 18 billion
respectively. Since most companies in this market sell to distributors, it’s a
bidding war to get your product to be included in the major distributor’s
inventory. This gives all the power to the distributors, which causes the industry
to be very competitive. When a new company comes around, they might need
to invest high costs in brand advertising to reach customers who are already
familiar with existing brands. A company like Sara Lee will not have to do this.
With such a strong presence of economies of scale and maturity in this industry
there is little chance of new firms being able to gain access to the market and
15
compete. This creates a very large barrier for new companies to join this
industry.
First Mover Advantage
First mover advantages in this industry are created when a company has
strong relationships with distributors and suppliers. Typically those companies,
like Sara Lee, have been around for a long time to establish those relationships.
The first mover advantages in this industry are very important to the success of
competing companies. The top companies (PepsiCo, General Mills, Kellogg, and
Sara Lee) have all been around at least 65 years, and customers are already
aware of their brands and products. Brand awareness is essential because
suppliers and consumers typically choose the brands they are familiar with, and
ones that are cheap. When a company has this first mover advantage, it makes
it easier to compete with prices because they don’t have to spend a lot on
marketing or advertising to get customers familiar with their brands. In order to
utilize the first mover advantage, companies have to try and find new ways to
make their brands as recognizable as possible so that customers can gain
familiarization and trust with certain brands. Sara Lee attempts this by
spreading their brands to many different markets such as food, beverage,
household, body care, and apparel (which was spun off recently). Low switching
costs, however, can actually make joining this industry easier for new companies
because with such a highly competitive market and with the products being sold
by these companies not having much difference with each other, a new company
might not have many problems making customers switch brands.
Distribution Access
The access to distribution probably poses the biggest difficulties to new
entrants. The distributors in the processed and packaged goods industry, such
16
as Wal-Mart, have a lot of power in deciding what brands they are going to
carry. It is a lot less risky for these distributors to carry a brand that they
already know about and that already has loyal customers that go to certain
distributors to buy their preferred brands. Sara Lee currently sells 15.6% of their
total Net Sales to Wal-Mart (their biggest customer). Establishing relationships
with these distributors in this industry takes time, and it would be difficult for
new companies to come and get access to the big distributors who already have
the brands that they usually buy from.
Overall, the threat of new entrants in the processed and packaged goods
industry is fairly low due to the difficulties to compete with the big, existing
companies. The most effective way to prove this is by showing that the leaders
in this industry have all been in business a very long time. Since Sara Lee has
been around since 1939, it has already had the opportunity to work with retailers
and gain a strong hold in the distribution channels. Firms trying to enter this
industry would find great difficulty trying to duplicate such distribution access.
Threat of Substitute Products
A substitute product is any product that can be consumed in the place of
another product. A substitute product does not have to be identical; it only has
to perform the same function. The threat of a substitute product is important
because a substitute product forces the industry to change and adapt to the
market. Without a substitute product the market is forced to change and adapt
to the industry. When the threat of a substitute product is high the industry
becomes a price taker and unless the food industry can cut cost in operations or
production they will see a reduction in their profit margin when competing with a
substitute products’ prices. A low threat of substitute products means there is
little or no competition and the industry does not have to conform to or compete
17
with the market and therefore is able to determine any market price for their
product. In this situation profit potential is unlimited and determined by the
industries price and the consumers’ willingness to purchase the industries
product.
The food industry produces a product that is a necessity for its customers
and consumers will always be willing to purchase. The only threat to the
processed and packaged foods industry in terms of substitute products would
come from sources such as restaurants and possibly organic foods. This threat
appears to be minimal since the even given the slight increase in organic food
sales which most likely is a fad. And competition with restaurants is long
established and unlikely to undergo any major changes. Therefore, the only
potential caps on profitability for the food industry are a moral obligation to its
customers and American or international government regulation. The food
industry supplies a product that its customers cannot live without and therefore
could be morally responsible to charge a price that is affordable at every income
level. As with every industry the government could place a cap on prices to
uphold the industries moral responsibility. The possibility that another industry
would be able to replicate the function of food without making a food product is
extremely unlikely if not impossible. There is a low threat of substitute products
to the food industry, because buyers’ have to have the product and the product
is extremely hard to replicate.
Bargaining Power of Buyers
Customers bargaining power in an industry is an important part of
determining industry profitability, because it relates to a firms ability to set prices
in the market, and determine what kind of class their industry is, ranging from
perfect competition to a monopoly. If customers set prices then the firm has
18
little chance for supernormal profits. There are two factors that determine
bargaining power of the customer. One factor is price sensitivity which is the
extent buyers will go to in order to bargain on price. If products are
undifferentiated then bargaining power is high, because buyers have many
options. The other factor contributing to the buyer's power is their relative
bargaining power which is ultimately the opportunity cost of one party not doing
business with the other party. Buyer's relative bargaining power will be high in a
market where the number of sellers is high in relation to the number of buyers.
If the market has many product alternatives then buyer's power will also be high.
Another consideration in assessing the customer’s power is their volume of
purchases. For example a mass retailer such as wal-mart has a great deal of
power over its suppliers do to their large amount of purchases.
In the processed and packaged good industry the buyers have a
relatively high bargaining power. This is due to the products offered generally
being undifferentiated giving customers the option to easily buy alternative
products. Also the brand-name consumer products industry is intensely
competitive with a large number of firms. In order to protect their existing
market share or gain new market share in a highly competitive retail
environment firms will have to be able to offer competitive prices on products to
meet the buyer's demands. Such pressures also may restrict the ability to
increase prices in response to raw material and other cost increases, which could
possibly lead to lower profit margins. Firms may try to offset these forces by
introducing new products to the market and by promoting their existing products
through advertising campaigns. Another way firms attempt to offset buyer's
power is by producing high quality products to try and gain customer loyalty and
repeat business. They also may try to cut cost through vertical integration by
owning and operating production and manufacturing facilities. Even with these
measures in place, customers have substantial bargaining power relative to the
firms in the processed and packaged good industry.
19
Bargaining Power of Suppliers
Bargaining power of suppliers is a mirror image of the bargaining power of
buyers. The power of suppliers directly relates to a firms ability to control cost
and ultimately profits. Firms will have buyer power if the number of suppliers
offering the same product is high due to the ease of switching suppliers with
little costs. Also, if a supplier sells large quantities to a single buyer then the
buyer will have the bargaining power. In the processed and packaged good
industry firms like Kraft or General Mills claim they mostly deal in commodities
either for the products or their packaging. This gives firms the bargaining power
since there are a large number of commodity suppliers offering identical products
or product substitutes. There are also little switching costs for firms, if sellers
try to raise prices they will likely be undercut and firms will choose to buy from
another supplier while incurring little or no cost. Another factor taking power
from suppliers is that they generally sell to firms in very large quantities and
cannot afford to lose the sale. Firms like Con Agra and Pepsico. buy huge
amounts of raw materials, like corn, flour and sweeteners every year. If a
supplier were to lose these huge sales due to a price war it would be devastating
to them. These facts show that the bargaining power of suppliers in this
industry is low. This gives firms the ability to control costs and maintain
profitability.
Characterization of Industry
In the profitability analysis of the Processed & Packaged Goods industry,
using the five forces model, we find many important points. The first is that
there is a high degree of rivalry among existing firms. This is illustrated by the
low industry growth rate and high concentration of firms, with most major firms
20
having fairly equal and unchanging market shares. Second with existing firms
having well established distribution access, good relationships with buyers, and
established scale of economies shows a low threat of new entrants to the
industry. Third the processed and packaged goods industry has a low threat of
substitute products given the need to offer low prices in order to maintain
market share. The bargaining power of buyers in the industry is also high due to
products generally being undifferentiated and offering low switching cost to
buyers. Also suppliers have a low level of bargaining power given the high
number of suppliers offering the same goods. The processed and packaged
goods industry is a highly competitive one with all firms having to fight for
market share. Given this information about the industry, firms have a fairly low
profitability potential. Firms that want to gain a competitive advantage will have
to implement some sort of cost leadership techniques or offer some level of
product differentiation, but they will most likely have to display a mixture of
both.
Value Chain Analysis: Key Success Factors
In order to be successful in an industry firms must be able to identify and
develop key success factors within its industry. By doing so, they will enjoy
greater profits and an established position among competitors. Given the Five
Forces model, showing a highly competitive industry and somewhat equal market
share, strategies for gaining competitive advantage in the processed & packaged
goods industry are a combination of cost leadership and differentiation with most
of the emphasis on cost leadership. Firms that can obtain cost leadership will be
able to earn greater profits by charging the same price as competition while
maintaining lower total costs. Another ability that a cost leader has is to cut
prices and gain market share or even force competitors out of the market. Firms
that implement the differentiation strategy will be able to increase sales by
21
offering a unique product that has greater value to consumers. The
differentiation strategy is primarily not used in industries like the processed and
packaged goods industries because most of these firm’s products are
commodities which use the Cost Leadership strategy.
Cost Leadership
To achieve cost leadership in this industry firms will want to develop
economies of scale and scope. Economies of scale are achieved by buying and
producing in mass quantities and still maintaining an efficient use of resources.
Since fixed costs such as plants and equipment are unchanged an increasing in
production quantity will spread these cost over a greater number of units and
lower average cost with the production of each additional unit. Economies of
scope will occur if a firm produces an increased number of different goods, while
keeping its asset base low to lower its average total cost and increase profits. If
production and storage facilities are used for more than one product then the
average cost is dispersed over more products. For example, if a firm is able to
produce numerous products cheaper than to separate firms then they exist in an
economy of scope. In the processed and packaged goods industry we see
success in firms that operate in economies of scale and scope. Another means
for gaining cost leadership is to develop efficient production means. By using
resources efficiently firms reduce unnecessary costs. Lowering input and
distribution costs are also important to become a cost leader. Buying goods in
large quantities can increase a firms bargaining power over its suppliers and
reduce the cost of inputs. Without having cost leadership firms would have few
ways to control costs and with their buyers having a lot of bargaining power they
would not be able to recuperate costs.
22
Differentiation
Differentiation in the processed and packaged goods industry can be
achieved by supplying a unique product at lower price premium than customers
are willing to pay. Superior product quality is another differentiation strategy
that will develop competitive advantage and increase profits. Customer will be
willing to pay more for a good of higher quality. Offering a variety of products to
customers can also create differentiation for a firm. Firms in the industry can
also invest in their brand image, creating favorable recognition with customers.
These strategies promote customer satisfaction, loyalty and repeat business
which will in turn generate more profits and give the ability to gain greater
market share. Differentiation can bring success to firms in the processed and
packaged goods industry since the products are generally the same.
Competitive Advantage Analysis
Usually a company will use one of two approaches: cost leadership or
differentiation. Cost leadership is used when a company is in a highly
competitive industry with products that are similar, and differentiation is used
when a company is in a less competitive industry with products that are
noticeably different. The processed and packaged good industry is a highly
competitive one with many large firms holding fairly equal market share.
In
order for firms to be successful they must be able to identify and implement key
strategies to gain competitive advantage. When considering the processed and
packaged goods industry, Sara Lee obviously must compete with price against its
competitors, but price is not the only factor. Sara Lee tries to make its products
at a quality level higher than most of its competitors. This allows them to sell a
slightly higher-priced product without losing sales due to the higher price.
Although price is the main competing edge in this industry, a little differentiation
23
used by Sara Lee gives them a competitive edge. Sara Lee’s success from
previous year shows they demonstrate competitive advantage at some level in
their industry. Sara Lee corp. has chosen to strive for competitive advantage in
the areas discussed in this section.
Cost Leadership
Cost leadership in this industry can be gained through economies of scale
and scope, efficiency within the industry, and lowering input costs. Sara Lee has
substantial cost leadership in the processed and packaged good industry, which
is its main concern in regard to gaining a competitive advantage. Several
measures contribute to their strong stance in this area as we will discuss below.
Economies of Scale
Operating in an economy of scale will allow a firm to increase their
production, lower their average total cost and enjoy larger returns. Sara Lee’s
large size and sales volume allows them to be in an economy of scale. They are
continuously trying to transform their business in order to be better in this area.
As part of the transformation, Sara Lee is consolidating the headquarters of its
North American businesses to one location in the Chicago area and the
headquarters of its European businesses to one location in Utrecht, the
Netherlands (Sara Lee 10k). Also, due to the transformation Sara Lee is going
through, it is reducing the number of product lines it runs. This allows the
company to focus on a smaller number of product lines. This reduces costs and
allows for higher quality. Sara Lee is trying to focus mainly on the food sector in
the United States and Europe, and also household products in Europe. Currently
this transformation is causing loses for Sara Lee. This is shown by the $62
million dollar loss in the fourth quarter of 2006 (yahoo.com/finance). But in the
24
long run Sara Lee will be able to grow its main product lines to be profitable.
This transformation will help its economy of scale.
Economies of Scope
A firm in this industry able to operate in an economy of scope will enjoy
sales from a variety of products and lower average costs than a firm producing
only one product. Sara Lee offers a wide variety of goods produced within its
seven business sectors. North American Retail Meats, which operates in north
America, sells a variety of packaged meat products such as, hot dogs, corn
dogs, sausages and sandwiches, smoked and dinner sausages, premium deli and
luncheon meats, bacon, and cooked and dry hams. North American Retail Bakery
sells a wide variety of fresh and frozen baked products and specialty items to
retail customers in North America. Products include bread, buns, bagels, rolls,
muffins, specialty bread, frozen pies, cakes, cheesecakes and other desserts.
International Bakery sells a variety of bakery and dough products to retail and
foodservice customers in Europe and Australia. Products include a variety of
bread, buns, rolls, specialty bread, refrigerated dough, frozen desserts and ice
cream. Foodservice sells a variety of meats, bakery and beverage products to
foodservice customers in North America. Products include hot dogs and corn
dogs, breakfast sausages and sandwiches, smoked and dinner sausages,
premium deli and luncheon meats, bacon, meat snacks, cooked and dry hams,
bread, buns, bagels, rolls, muffins, specialty bread, refrigerated dough, frozen
pies, cakes, cheesecakes, roast, ground and liquid coffee, cappuccinos, lattes,
teas, and a variety of sauces, dressings and condiments. International Beverage
sells coffee and tea products in major markets around the world, including
Europe, Australia and Brazil. Household and Body Care sells products in four
primary categories: body care, air care, shoe care and insecticides. Body care
consists of soaps, shampoos, bath and shower products, deodorants, shaving
creams and toothpastes, which are sold primarily in Europe. The branded
25
apparel segment designs, manufactures, sources, and sells a broad range of
apparel essentials such as t-shirts, bras, panties, men’s underwear, kids’
underwear, socks, hosiery, casual wear and active wear. On September 5, 2006,
Sara Lee spun off the branded apparel segment into an independent, publicly
traded business named Hanesbrands Inc. (Sara Lee10k) Sara Lee displays strong
economies of scope is shown through their production of so many different
goods, this has helped create a cost leadership quality that will be valuable for
many years.
Efficiency in the Industry
Maintaining a high level of efficiency in this industry is essential in order to
keep costs low and attain competitive advantage. The Sara Lee Corporation has
taken several steps in order to increase their operating efficiency. One way the
firm strives to be efficient is that they reorganized their business operations in
the beginning of fiscal 2006. This reorganization is an attempt to steer focus
around distinct consumers, customers, and geographic regions. As a result, the
business is organized around seven business segments: North American Retail
Meats, North American Retail Bakery, Foodservice, International Beverage,
International Bakery, Household and Body Care and Branded Apparel. The
success of these actions has yet to be seen.
Sara Lee has also recently decided to change its business portfolio and
narrow its focus on its 3 key products businesses: food, beverage, and
household products. Their strategy for this was the disposal of certain
businesses. During fiscal 2006, Sara Lee disposed of its Direct Selling, European
Branded Apparel, U.K. Apparel, U.S. Retail Coffee, European Nuts and Snacks,
and U.S. Meat Snacks businesses. In August 2006, after the end of fiscal year
2006, Sara Lee completed the sale of its European Meats business. Additionally,
on September 5, 2006, Sara Lee completed the spin off of its Branded Apparel
26
Americas/Asia business, which was spun off as an independent public company
named “Hanesbrands Inc.”(Sara Lee 10k). Sara Lee claims to continuously
implement methods of improving their operational efficiency, by streamlining its
processes and centralizing its procurement and information technology across
the organization.
Low Input Costs
Sara Lee uses many different commodities for production in their various
businesses. They do exercise a level of bargaining power over suppliers do to a
large purchases volume. However, commodity prices are volatile and subject to
market fluctuations, weather, currency fluctuations and changes in governmental
agricultural programs. Sara Lee does use commodity financial instruments, such
as future contracts, in order to circumvent price increases but not at significant
levels (Sara Lee 10k). Sara Lee may be able to pass on some or all of an
increase in the price of raw materials to their customers by increasing their
prices, but this could lead to lower sales volume since customers bargaining
power is high in this industry. Sara Lee does not implement strong measures in
lowering input costs. An increase in commodity prices would increase raw
material costs and operating costs and may reduce profitability.
Differentiation
While the cost leadership method dominates most of Sara Lee’s
competitive advantage strategies, they also try to gain a little different
advantage over competition in this industry by implementing a few differentiation
strategies as well. Quality, brand names and others are among Sara Lee’s top
strategy for having competitive advantage.
27
Superior Product Quality
Consumers will be willing to pay more for goods with a high rate of
quality. A firm in this industry that offers goods products of superior quality will
be able to have higher asking prices than other firms. Sara Lee strives to
maintain the highest level of quality possible in the goods that it offers to its
customers. Advertising campaigns for Sara Lee’s many brands often tell of the
products high quality or quality guarantee. Their web site boasts, “You can trust
Sara Lee to use quality ingredients, so your family can enjoy great tasting meals
that fit today's busy lifestyles (SaraLee.com).” Sara Lee has decided that
product quality and perception of quality are strong factors in its profitability.
High quality is a key part of Sara Lee’s ability to attain differentiation in their
industry.
Superior Product Variety
Sara Lee offers a wide variety of products to customers all over the world.
Its food sector offers a wide variety of packaged meat products, bakery
products, coffees, and teas. Its household and body care sector sells body care,
air care, shoe care and insecticides. Its North American retail meats accounted
for 15.9% of revenues in 2006. Combined retail bakery products grabbed about
20% of revenues in 2006. The international beverage gained 14.7% of revenues
in 2006. In offering such a large product variety to customers Sara Lee is able to
satisfy more buyers in its industry. Also by reaching a vast amount of customers
it can gain more loyalty to its brand name.
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Investment in Brand Image
A good brand image can cause customers to buy a product just because
of name and logo on it. Good brand names can also be a symbol of high quality.
Sara Lee owns approximately 28,000 active trademark registrations and
applications in countries around the world (excluding trademarks transferred to
Hanesbrands Inc. in connection with the spin off). Sara Lee feels that its brand
names are one of its biggest assets as it builds brands globally (Sara Lee10k).
Its brands includes registered names, but also proprietary trade secrets,
technology, know-how processes and other intellectual property rights that are
not registered but valued as an asset to the company. Sara Lee is confident that
its trademark registrations are well protected under the laws of all the countries
that it operates in (Sara lee 10k). The Sara Lee web site states, in the page
dedicated to brands, that, “At Sara Lee Corporation our business is brands.
Leading brands. Trusted brands. Great brands like Hillshire Farm, Jimmy Dean,
Senseo, Douwe Egberts, Ambi Pur, Kiwi and of course, our namesake, Sara Lee.”
Sara Lee’s strong brands in all sectors should be a valuable asset for the
foreseeable future.
Research and Development
For years, Sara Lee has ignored research and development of new
products. This had worked for the company for most of its existence. Starting
around 2005 the company began to noticeably take a turn in the wrong
direction. According to the Chicago Tribune, the stock price for Sara Lee has slid
23% since 2005, and earnings for 2006 were half of what they were in 2004 in
similar sales. Top company executives feel the lack of R&D is a major
contributor to the downturn. In response, the company is launching a
progressive R&D project. They have begun building a R&D campus near their
29
Chicago headquarters that will be completed in 2009, and they will increase R&D
employment by 50%.
The increase in the competitive advantage is slowly starting to appear.
The company has developed new products such as: Jimmy Dean Skillets,
Breakfast Bowls, Hillshire Farm Salad Kits, and Flavor Fusion Pies. Sara Lee must
maintain some sort of competitive advantage in the following years in order to
remain competitive. The most important strategy is cost leadership but
differentiation can cause a healthy profit margin. Sara Lee demonstrates a string
ability to keep costs low, competitive and also maintain a level of differentiation
above its competitors.
Accounting Analysis
Accounting analysis is a crucial step in understanding what key accounting
policies are being utilized by the company. It also allows investors and the
general public to view the current financial position of the firm, as well as make
future financial forecasts. As analysts it is beneficial for us to evaluate the
accounting procedures of Sara Lee. We have to ensure that Sara Lee has
accurately and effectively reported its financial information. We must determine
if there are any errors whether intentional or unintentional. If there are
inaccurate numbers we must revise the various accounting data to give us a
better portrayal of the value of Sara Lee.
Key Accounting Policies
When performing an accounting analysis, several steps and procedures
are essential in order to help one evaluate the firms’ accounting standards and
quality. The first step is to identify key accounting policies. When identifying the
30
key accounting policies, it is vital to pinpoint the key success factors of the firm
and evaluate whether or not Sara Lee is using these factors as value drivers for
the firm.
Sara Lee’s growth seems to be driven by marketing and advertising of
their products, offering products of highest quality at the lowest price possible,
customer excellence, customer driven innovation, efficient inventory
management, and geographic expansion. Sara Lee currently has numerous
operating leases for its manufacturing facilities, warehouses, office buildings,
vehicles, and operating machinery. This allows Sara Lee to not have to show
these facilities, warehouses, and machinery as assets on its balance sheet, as
well as to not have to disclose these as liabilities for the company. Sara Lee also
has contingent leases obligations, which represent leases that are operated by
others and only become a liability for the company if those other companies are
not able to meet their leasing obligations. The operating leases within the noncontingent lease obligations constitute such a small portion of their noncontingent liabilities that it is difficult to say that they play a part in any type of
manipulation or distortion of future forecasted liabilities.
Payments Due by Fiscal Year
In millions
Total
2007
2008
2009
2010
2011
Thereafter
Long-term debt
$4175
$368 $1369
$172
$38
$11
$2,217
Interest on debt obligations
1541
218
164
131
121
121
786
Operating lease obligations
616
136
110
87
71
60
152
2616
1711
352
228
192
106
27
624
232
67
25
19
17
264
9572
2665
2062
643
441
315
3446
188
26
24
23
20
16
79
$666 $461
$331
$3525
Purchase obligations
Other long-term liabilities
Subtotal
Contingent lease obligations
Total
$9760
$2691 $2086
31
Inventory is recognized on the balance sheet at the lower of cost or
market. Damaged inventory, excess inventory, as well as obsolete inventory is
recognized at net realizable value on the balance sheet. Spoilage rates, historical
recovery rates, and forecasted marketing and sales plans help in determining the
amount of net realizable value for these types of inventory.
COGS/Inventory
7
6
5
Sara Lee
4
General Mills
Kraft
3
Conagra
2
1
0
2002
2003
2004
2005
2006
Year
The above graph demonstrates how Sara Lee is working toward becoming
a leaner and more efficient business. Sara Lee is reducing inventory in
comparison to the amount of goods sold. As inventory decreases the
COGS/Inventory ratio will increase. This is a good characteristic of a firm.
“[Managers of Sara Lee] have made dramatic progress in transforming Sara Lee
from a decentralized holding company into a smaller, integrated and more
efficient operating company.” (saralee.com). Sara Lee is pursuing this goal by
32
eliminating extra inventory and increasing shareholder value by issuing attractive
dividends and the repurchase of more than $500 million of its own shares, as
well as spinning off major brand names such as Hanesbrands Inc. (Hence, the
increase in the ratio from 2003-2006.) A corporation without extra inventory is a
more efficient corporation as a result. Not as much money is spent on holding
and maintaining inventory. Spinning off Hanesbrands will help Sara Lee. Sara
Lee will be able to lose distractions and focus on the core parts of their business
and do what they do best.
A portion of financial statements contain estimated numbers that are
based on historical and present information, which help decision makers make
critical determinations for the firms position in the future. For example, Sara
Lee, like many other companies, must estimate the amount of impairment
charges that it may undertake in the future. In order for goodwill to fall under
the “impairment charge” category, the fair value must be less than the carrying
value. This impairment charge decreases the value of goodwill to the fair market
value and symbolizes a “market-to-market” charge. Determining the fair value of
goodwill is as much an art as it is a science. This makes it difficult to forecast
impairment charges, because you can derive honest assumptions at different
valuations. The allocation process can also be manipulated in order to meet
management’s needs and preferences.
Accounting Flexibility
Sara Lee Corporation prepares its Financial Statements in accordance with
Generally Accepted Accounting Principles (GAAP). Since GAAP regulations can be
interpreted loosely in many areas, Sara Lee has flexibility in many areas of how
they report their operations on their financial reports. Flexibility of accounting is
highly affected by the policies that a corporation implements. Sara Lee’s policies
33
discussed in the previous section, such as reducing its inventory, play a major
part in how flexible Sara Lee is with its accounting strategy.
One example of flexibility that managers at Sara Lee have is how they
report their amounts of intangible assets, such as goodwill. According to GAAP
requirements, goodwill cannot be amortized, but is assessed for impairment
annually. Delaying the assessment of impairment can affect the value of longterm assets that will make total assets for that period overstated (Sara Lee 2006
Annual Report). In order to get an accurate estimate of impairment values,
managers at Sara Lee must estimate the fair value of an asset and compare that
to its carrying value. They make this estimate by looking at operating results,
business plans, and present value techniques. While it is management’s job to
make these estimates as accurate as possible, it is still an estimate and
management might be tempted to put their own twist on the data that is used in
these estimates. If these estimates are manipulated, it is likely that earnings will
be overstated in following periods. According to their 2006 Financial Report,
Sara Lee performs its annual review for goodwill impairments in the 2nd quarter
of each year.
Another example of accounting flexibility that Sara Lee faces is how to
evaluate its inventory. Management has the option of using the LIFO method,
FIFO method, or the average cost method. Sara Lee chooses to state 98% of its
inventories using the first-in, first-out (FIFO) method and the remaining 2%
using the last in, first out (LIFO) method. The FIFO method lowers the
company’s cost of goods sold, which is an expense, and will result in a higher net
income. FIFO also can have the risk of overstating assets because of the
possibility of inventory being overstated. The decision of which method to use
does not have a large impact in this particular industry of consumer products due
to the short amount of time that inventory is received and sold, but it can still
make a slight difference in accounting numbers.
34
Another area of flexibility related to inventory is how management values
the cost of inventory. Sara Lee shows its inventory on the balance sheet at
lower of cost or market, which is required by GAAP. However, damaged or
obsolete inventory is valued at net realizable value, which is evaluated using
estimates made by management, and may involve uncertainties (Sara Lee 2006
Annual Report). Flexibility can also be shown if a company offers discounts or
rebates which might be due to surplus inventory. If managers over-buy or overproduce in the current period, they are likely to have to offer customers
discounts to lower surplus inventories (Palepu 4-7). Sara Lee has the option to
offer discounts to vendors that relate to inventory. These discounts are a
reduction of costs of the items and are reflected in cost of sales. Discounts of
surplus inventory could be a result from delaying a write down from a current
asset (inventory) which would be overstating assets.
Pensions and other post-retirement plans are other examples of
accounting flexibility that management are faced with. In order to obtain the
values of pension obligations, management must estimate the projected value of
future pension payments using discount rates, salary growth, expected return on
plan assets, retirement rates, and mortality (Sara Lee 2006 Annual Report).
Manipulating these estimates can result in an understatement of benefit
obligations, which will cause expenses to be understated. This chart illustrates
the sensitivity of a 1% change in the discount rate, which is determined by
utilizing the yield on high-quality fixed-income investments that have an AA bond
rating and last as long as the average life of the pension obligations.
35
(In millions)
Increase/(Decrease) in
2007 Net
2006
Periodic
Projected
Benefit
Benefit
Assumption
Change
Cost
Obligation
Discount rate
1% increase
$(50)
$ (828)
Discount rate
1% decrease
98
1,043
Asset return
1% increase
(47)
–
Asset return
1% decrease
47
–
(Sara Lee 2006 Annual Report)
According to the chart a 1% change in the discount rate in the current
period of projections for pension benefit obligations can either overstate or
understate the following period’s costs by a $50 million understatement or a $98
million overstatement. This means there is a heavy influence on the estimation
of discount rates by the accounting managers within the firm. Just one percent
can make the difference in a conservative or aggressive approach.
Accounting Strategies
Accounting strategy is how managers implement their accounting
flexibility. Strategy can vary largely. Usually a firm is described as conservative
or aggressive. Conservative companies will show less net income and aggressive
companies will show more net income typically. Being on the far end of either
side of the scale is almost always considered to be a negative quality.
36
According to the company’s 2006 annual report, Sara Lee uses lower of
cost or market values to value their inventory. Sara Lee uses the first in, first out
(FIFO) inventory method for 98% of its inventory to determine the cost of its
inventory. The remainder (2%) of their inventory is valued by the last in, first
out (LIFO) inventory method. This is standard with GAAP and the rest of the
industry.
When it comes to the potential of managers manipulating future
forecasted liabilities, it is important to consider the company’s pension plans.
Sara Lee happens to use defined benefit pension plans across its spectrum of
divisions, where the benefits that are provided by these plans are based on the
number of years of service provided by the employee and their level of
compensation. With a company as large as Sara Lee, pension expenses are a
significant cost to the company, making it an incentive for unethical managers
and top executives to manipulate these numbers to their liking. By using defined
benefit plans, Sara Lee must forecast the life expectancy of these plans, as well
as salary inflation. Sara Lee discloses that these obligations are estimated by
“using actuarial assumption, based on the current economic environment.” (Sara
Lee 10-K). This statement clearly represents the amount of flexibility that is
given when using this type of pension plan, as well as the potential to alter
liabilities for the future.
Summary of cash contributions
Continuing operations
Discontinued operations
Total
$326
$327
$104
5
21
8
$331
$348
$112
(Sara Lee 10-k)
When forecasting future pension plan liabilities Sara Lee’s managers are
required to offset employee working commitments with the assets that the firm
37
has committed in helping fund retirement and future pension benefits (Palepu 427). Sara Lee must have enough funds set aside to cover its plan commitments.
If the funds set aside by the firm fall short of its commitments the plan is underfunded, and vice versa for an over funding of pension reserves. When selling off
a business, such as its United Kingdom apparel business, Sara Lee must continue
to recognize the pension obligations that were related with that business. With
Sara Lee no longer having to incur these obligations, the cost is then recognized
in discontinued operations.
(in millions)
2006
2005
$4265
$4281
Accumulated benefit obligation
4159
4080
Fair value of plan assets
3163
2916
Projected benefit obligation
(Sara Lee 10-K)
Sara Lee also breaks their benefit obligation plans into two categories:
accumulated benefit obligation and projected benefit obligation. Accumulated
benefit obligation are portrayed based on employee service and compensation.
This measurement differs from the projected benefit obligation plan because it
contains no forecasts or assumptions about future compensation. Sara Lee also
contributes to a number of investment objectives such as: equity securities, debt
securities, and real estate in order to help pension plans meet their full potential.
38
Pension Expense/SG&A Expense
0.09
0.08
0.07
0.06
0.05
Pension/SG&A
0.04
0.03
0.02
0.01
0.00
2004
2005
2006
Year
One noticeable factor that affects accounting strategy is that Sara Lee
offers high bonuses and/or incentives to high-performing employees within its
company. They are fairly aggressive in this area. These bonuses are based on
items such as profits, sales, cash flows, and individual achievement on projects.
There are five levels of achievement; the highest level of achievement receives
150% of the target bonus. This gives employees in top management positions a
strong incentive to have good accounting numbers for a particular period. It
would not be unforeseeable for managers to distort accounting policies to
achieve high sales or profits in order to receive higher bonuses. Sara Lee has
made recent changes to there performance measures used for bonuses. In
2006, Sara Lee added another level of performance and put sales goals on a
different measuring system. See charts below.
39
Performance Level 2006
Performance Goal
Performance
Payout Level
(Operating Profit,
Goal
as a % of
Cash Flow, Individual
(Sales)
Target Bonus
Objectives)
Level 5 Maximum
110% of Target
105% of Target
150
%
Level 4 Above Target
105% of Target
102.5% of Target
135
%
Level 3 Target
Target
100% of Target
100
%
Level 2 Below Target
95% of Target
97.5% of Target
50
%
Level 1 Threshold
90% of Target
95% of Target
0
%
Performance Level 2005
Performance Goal
Pay out Level as a %
of Target Bonus
Level 4 - Maximum
110% of AOP
150%
Level 3 - Target
AOP
100%
Level 2 - Below Target
95% of AOP
50%
Level 1 - Threshold
90% of AOP
0%
Sara Lee appears to not use business transactions to achieve certain
accounting objectives. They are relatively conservative when they are concerned
about future losses from possible scenarios. In its 10-K report the company
mentions several factors showing this quality. In September 2006, Sara Lee
spun-off a section of its branded clothing division. In terms of short-term
success this move will actually hurt Sara Lee. Their 10-K reports that the move
actually will end up costing them more in taxes. The company also is investing
greatly in a transformation project. Significant amounts of money are being
spent on this transformation along with research and development. This project
is scheduled to last for three more years. Companies looking deep into the
future to achieve long-term profits make moves such as these exhibited by Sara
Lee.
One negative effect is currently taking place due to this transformation
that could possibly affect accounting strategy. Many internal management
40
positions are being moved, and new, different people are being placed in those
positions. This flow of new managers brings the threat of inconsistencies within
the accounting decisions made across this worldwide corporation. This means a
different perspective could arise in terms of accounting policies. The company
recognizes this potential problem in their 10-K, and is ready to tackle this
potential threat.
We feel that Sara Lee is not an aggressive firm in terms of accounting
strategy, but at the same time not too conservative. Sara Lee makes its
accounting decisions to fit whichever scenario is prevalent, and make sure that
the owners of the firm are accurately well-informed about the financial standing
of the company. Sara Lee is a highly disclosed company. Some analysts might
view this technique as a way to bog down information, but we feel that Sara Lee
wants the public to be fully informed about the company. To take a stance as
either conservative or aggressive, we must say that Sara Lee is conservative in a
healthy manner.
Quality of Disclosure
The quality level of a firm’s accounting disclosure is a main factor in
determining their true business reality. A high level of quality disclosure would
equate to a high level of transparency and can make it easier for analysts and
investors to determine the value of a company. A low level of disclosure may
cloud the true economic situation of a firm making analysis more time consuming
and possibly less accurate. Managers have the ability to alter the level of the
accounting disclosure and portray their company to be a better investment
choice than it truly is by choosing accounting methods that imply high earnings.
Top managers may try to appear as having earned lower income to save on
taxes or show steady signs of growth.
41
Qualitative
A firm’s disclosure can by considered in two categories, qualitative and
quantitative. Sara Lee appears to demonstrate a high level of qualitative
disclosure to the public, through its annual summary reports, letter to
shareholders and footnotes. These reports offer a clear view of their business
environment and a break down of performance by sectors and regions. Sara Lee
clearly explains their methods, procedures and strategies for success. In the
annual report found on the Sara lee website management discusses its goals for
growth and plans to attain it. Management also discusses accounting methods
such as the accounting of goodwill and what types of leases they use, as well as
give logical explanations for these decisions. Sara Lee’s annual report seems to
make no attempt to hide bad news or risks that it may face. Overall, their 10-k
gives good quality in-depth information of the company’s financials as well as
explanations of choices and unexpected events.
Quantitative
Quantitative information found in the 10k is another major factor in
determining a company’s level of disclosure. Although much of the information
has regulations and guidelines on how to account for certain transactions,
managers still have discretion over a significant portion. With this discretion,
managers can distort financial truths and make it difficult to assess a firm’s true
value. Due to incentives and pressures that top managers face each day to meet
earnings goals, analyzing quantitative accounting data over several years and
comparing it to firms within the industry is imperative. The following diagnostic
will attempt to analyze the firms accounting methods as well as some
competitors in the industry.
42
Manipulation Diagnostics
Ratio Analysis:
The following charts summarize accounting ratios for Sara Lee and two of
its major competitors: Kraft and General Mills. The ratios are broken down into
two categories: Revenues diagnostics and expense diagnostics. We selected
these ratios to screen in order to perceive any type of out of the ordinary ratios
that may stand out among possible trends over a five year period.
Revenue Diagnostics:
The revenues diagnostics indicate how much revenue is being generated
from sales, accounts receivable or inventory, depending on which ratio you are
interested in. These ratios are important because they show an important
linkage between revenues, sales, accounts receivable and inventory, which can
ultimately help reveal any signs of number manipulation.
43
Net Sales/Cash from Sales
1.02
1.01
1.01
Sara Lee
General Mills
Kraft
1.00
1.00
0.99
0.99
0.98
2002 2003 2004 2005 2006
Year
The Net Sales/Cash from Sales ratio shows the relationship between
actual sales and the cash received for those sales. The industry is relatively
close to one another over the five year span. If a company were to have a ratio
of 1 in this category, it would indicate that all sales dollars were being collected
as cash. A firm could rise above this number without need for concern if they
are growing at a fast pace. The packaged goods industry ratio hovers around a
1, showing that there is a safe level of cash from sales. Sara Lee is an example
of a good ratio over the entire five year time frame. Sara Lee’s steady ratio of
around 1 conveys no level of concern or effort of trying to manipulate sales or
cash from sales. Their competitor’s ratio hovers around a 1 as well. This
indicates that Sara Lee seems to be keeping up with the competition when it
comes to collecting cash and limiting their risk of accounts receivable.
44
Net Sales/Acct. Receivable
12
10
8
Sara Lee
General Mills
Kraft
6
4
2
0
2002
2003
2004
2005
2006
Year
A large ratio is good for Net Sales/Net Accounts Receivable. A large
number means a company collects a large portion of their sales; this quality
relieves the threat of uncollectible accounts. The industry is very consistent
except for General Mills up and down fluctuation of their ratio from 2002 to
2005. Sara Lee ranks last among the industry for the last five years, in which
they had been increasing their ratio until 2005 where they experienced a slight
decrease due to a drop in sales and increase in accounts receivable. Sara Lee’s
consistency of outputting a small (net sales/net accounts receivable) seems to be
caused by their lower sales and higher accounts receivable relative to the
competition. Sara Lee seems to maintain a steady ratio over the entire five
years, which causes no concern of any type of manipulation.
45
Net Sales/Inventory
12
10
8
Sara Lee
General Mills
Kraft
6
4
2
0
2002
2003
2004
2005
2006
Year
The industry is not as consistent in this ratio as the previous two. A larger
sales/inventory ratio is more desirable. It means a company is moving their
inventory quickly and efficiently. Sara Lee is at the bottom of the pack compared
to General Mills and Kraft. Sara Lee’s ratio increased largely from 2004 to 2005,
but this was due to a decrease in inventory of nearly $600 million. Sara Lee’s
ratios seem to be consistent and straightforward, showing no evidence of
manipulation.
Expense Diagnostics:
The expense diagnostic ratios help one analyze how accurate a company
is reporting their expenses. A majority of these ratios indicate how much cash a
company is generating from assets, operating income, net operating assets and
change in sales. Like revenue diagnostics, expense diagnostics provide an
important linkage between cash and these other items, which ultimately help in
recognizing any type of manipulation that may occur.
46
Asset Turnover
1.20
1.00
0.80
Sara Lee
General Mills
Kraft
0.60
0.40
0.20
0.00
2002 2003 2004 2005 2006
Year
The asset turnover ratio shows how much sales are generated from total
assets; the ratio is stated as Sales/Assets. Sara Lee uses operating leases which
could explain there relatively high ratio. The increase in Sara Lee’s ratio from
2003 to the end of 2005 can be explained by a larger increase in their sales
relative to their total assets. The industry shows little movement over the entire
five year period. Sara Lee stays quite constant as well and shows no signs of
manipulating sales or total assets.
47
CFFO/Operating Income
2.5
2
Sara Lee
General Mills
Kraft
1.5
1
0.5
0
2002
2003
2004
2005
2006
Year
This ratio shows how much cash is generated from operating activities. A high
number means a lot of cash was created from operating activities. Sara Lee is
on top of the industry in this category. This is a good thing for the company.
This shows that Sara Lee is collecting cash on their operating activities, which in
turns shows that the expenses that Sara Lee projects are accurate. The
consistent increase in this particular ratio for Sara Lee is explained by their cash
flow from operations being consistently higher than their operating income.
Although CFFO did decrease from 2004 to 2006, operating income had a $4
billion decrease from 2005 to 2006. In this particular case, Sara Lee seems to be
disclosing their information accurately with no signs of manipulation.
48
CFFO/Net Operating Assets
0.7
0.6
0.5
Sara Lee
General Mills
Kraft
0.4
0.3
0.2
0.1
0
2002
2003
2004
2005
2006
Year
CFFO/Net Operating Assets shows how much cash flow a company gets
out of its assets. There is lots of variance within the industry. Sara Lee has
declined in recent years, which means they are collected less cash for every
dollar of property, plant, and equipment they invest in. The large drop in Sara
Lee’s ratio is caused by a large decrease in their cash flow from operations from
2004 to 2006, relative to slight increases in their net operating assets. Although
their ratio dropped from 2004 to 2006, they seem to remain competitive and
accurate with their disclosures.
Potential Red flags
Even with guidelines such as GAAP, managers still have considerable
discretion in choosing accounting policy. Given their ability do distort numbers
and their incentive to do so identifying questionable accounting practices is an
important step in the analysis of a firms accounting and disclosure quality. Red
flags such as extreme changes in accounting policy or a high inconsistency of
financial numbers can reveal major changes to the way a firm is perceived in the
49
market. These red flags without proper justification will have an impact on the
firm’s financial status and therefore will require adjustments in order to fairly
value the company.
In the accounting analysis of Sara Lee we found a key item that
potentially could cause distortion in the firm’s financial reports. The first of
which is Sara Lee has a potential red flag concerning their fourth quarter net
incomes for 2005 and 2006. These numbers are more than likely not
intentionally distorted but do raise a legitimate concern. Please see the chart
below. The fourth quarter is highly irregular when compared to the numbers for
the first three quarters preceding. A reasonable answer to this irregularity
discussed in the firms 10k is the company transformation that Sara Lee is
undergoing. There is lots of restructuring and selling of company divisions
starting in 2005. These activities caused unusually high losses from discontinued
operations in 2005 and 2006 causing them to recognize after tax impairment
charges of 362 million and 256 million respectively (Sara Lee 10k). After
analyzing these unusual trends in the 4th quarter we found that legitimate
activities took place that justified the changes and we found no need for
adjustment.
Net Income By Quarter
2007
2006
2005
2004
2003
2002
Q1
$333
$67
$352
$230
$308
$242
Q2
-$62
$438
$326
$312
$348
$160
Q3
N/A
$42
$189
$376
$269
$257
Q4
N/A
$8
-$148
$354
$296
$351
Year
$271
$555
$719
$1,272
$1,221
$1,010
(Sara Lee 10-K)
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Undo Accounting Distortions
After reviewing the red flags found in our accounting analysis, we do not
believe any of them distort the accounting quality a significant amount. Also, we
feel that the low amount of operating leases used by Sara Lee do not distort the
company’s accounting numbers. Their operating leases total for all future years
was only $616 million. This is insignificant for a company that sales around $15
billion worth of product every year. Sara Lee does a superb job being welldisclosed and thorough in their accounting practices. They have consistent
numbers that show good policies in regard to accounting. Any change large
enough to draw attention was either well explained by management or had a
beneficial impact on the company, and is due to the restructuring attempts Sara
Lee has implemented.
Ratio Analysis and Forecast Financials
In determining a firm’s value an analyst must consider its profitability and
growth rate to better assess the implementation and success of its chosen
strategy. The two main tools used in doing so is the ratio analysis and the cash
flow analysis. Ratio analysis shows how different line items on a firm’s balance
sheet relate to one another and cash flow analysis helps to determine how a firm
manages cash flows from all aspect of their business (Palepu). Comparing the
results of the ratio analysis with a firms previous years, it’s competitors and
against the industry average can give an in depth look at how a firm handles its
operating, financing and investment cash flows. By running and understanding
financial ratios of past and present performance for the firm and its competitors,
as well as understanding the industry and accounting environment an analyst is
able to build a good foundation in which to make forecasts of future conditions.
51
Trend (Time Series) Analysis/Cross Sectional Analysis
The following analysis of Sara Lee and its competitor’s, Kraft (KFT) and
General Mills (GIS) is broken down in three categories: liquidity, profitability, and
the structure of capital. Financial ratios are a set of ratios that we are going to
be discussing in this analysis. By computing these ratios over a period of five
years, we will be able to recognize trends within the industry as well as Sara Lee,
and the factors that contribute to the trends.
Liquidity Ratios
A firm’s liquidity relates to its ability to meet and maintain its current
liability obligations in the short term with that of its cash and equivalence assets.
A highly liquid firm means that it is able to easily meet debt obligations given it’s
high level of current assets in relation to it’s current liabilities. For example a
current ratio of 2 would indicate a highly liquid firm, but a firm could still face
short term liquidity problems if some of the current assets were not easily turned
into cash. Therefore we will break the liquidity analysis down into 5 ratios
consisting of current ratio, quick asset ratio, inventory turnover, receivables
turnover and working capital turnover.
52
Current Ratio
2002
2003
2004
2005
2006
Sara Lee
0.91
1.14
1.06
1.19
1.08
General Mills
0.60
0.92
1.17
0.73
0.52
Kraft
1.04
1.03
1.07
0.93
0.79
The current ratio is found by dividing current assets by current liabilities to
show the amount of current assets in relation to current liabilities. This is a
somewhat a broad look at a firm’s ability to meet its short term debts with on
hand cash and other assets perceived to be fairly easy to convert into cash.
Generally the higher the current ratio is, the better the ability for the company to
pay back its obligations. Current assets consist of cash and cash equivalents,
short term investments, net receivables, inventory, and other current assets.
Current liabilities consist of accounts payable, short term and current long term
debt, as well as other current liabilities. Current assets are assets that can be
converted into cash, usually within at least one year or one business cycle;
whichever is longest. Current liabilities are a company’s debt that is due within
one year. With a current ratio below 1, a company may not be able to meet its
current short term obligations if they were due at that point in time. If a firms
current ratio is greater than 1 than they have more current assets than liabilities
and they should have no trouble meeting their debt obligations as well as
obtaining further financing. On the other hand, a current ratio that is too high
may mean that the company is not operating efficiently, as well as an indicator
that the assets are not being utilized efficiently.
53
Output
Current Ratio
1.4
1.2
1
0.8
0.6
0.4
0.2
0
Sara Lee
General
Mills
Kraft
2002
2003
2004
Years
2005
2006
Industry
Avg.
The above graph is a cross sectional analysis of Sara Lee’s current ratio
compared to General Mills and Kraft. In 2002, Kraft is the only company whose
ratio stays above a 1 due to their current assets being so much larger than their
current liabilities. In 2002, Sara Lee and Kraft were the only two in the industry
to maintain a current ratio above a 1; Sara Lees’ ratio being higher than Kraft’s
due their larger current assets relative to current liabilities. General Mills’ ratio
rises and surpasses everyone in the industry in 2004 due to a small increase is
current assets and a larger decrease in current liabilities of around $687 million.
Because of General Mills’ consistency of staying below a ratio of 1, this may
cause them to turn to alternative ways of financing their short term debt, which
is not good and may lead to bankruptcy in the long run. Sara Lees’ current ratio
seems to be very efficient over the entire 5 year time span. In 2002 the ratio fell
just below 1 due to a lower number of current assets compared to their higher
number of current liabilities. In 2005 their current ratio increased to a 1.19 due
to a decrease in their current liabilities of $397 million, followed by a smaller
increase in current assets of $207 million. The consistency of their steady
current asset ratio indicates that Sara Lee is definitely utilizing their current
assets to their fullest potential, as well as meeting their short term debt
obligations.
54
Quick Ratio
2002
2003
2004
2005
2006
Sara Lee
0.38
0.54
0.46
0.44
0.63
General Mills
0.35
0.49
0.64
0.38
0.28
Kraft
0.46
0.49
0.42
0.42
0.39
Quick asset ratio is found by dividing cash, accounts receivable and
securities by current liabilities and shows the relation of assets considered
extremely liquid to current liabilities. This ratio is important to consider in
respect to the current ratio since it does not take into account assets such as
inventory that may not be quickly converted into cash very quickly. A firm with a
high quick ratio shows the ability to cover its debts in an emergency situation
(Palepu). Sara Lees’ quick asset ratio increases by 0.25 from 2002 to 2006, due
to a substantial increase in cash, showing that Sara Lee is able to cover such
debts if needed.
55
Output
Quick Ratio
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
Sara Lee
General Mills
Kraft
Industry Avg.
2002 2003 2004 2005 2006
Years
The above table and graph show the quick ratios for Sara Lee, General
Mills, Kraft and the industry average. This particular graph shows Sara Lee
staying above the industry average in all years except 2004 when they dropped
to .46, and 2002 when they were at .38. In 2006 Sara Lee’s numbers rose to
.63, well above its competitors. While current liabilities did rise in 2006, the
increase in cash of $1.7 billion from 2005 to 2006 enabled Sara Lees’ quick asset
ratio to rise. This indicates that they have a strong ability to cover their short
term debts. From 2002 to 2004 General Mills was able to increase it’s ratio to
0.64, due to a decrease in current liabilities of nearly $3 billion; following that
their ratio drops to 0.28 in 2006 due to a considerable increase in current
liabilities of nearly $2 billion. Kraft maintains a ratio close to industry level up
until around 2003. From 2003 to 2004 Kraft’s current liabilities increased around
$1.2 billion, followed by an even larger increase in current liabilities of around
$1.7 billion in 2005 to 2006; resulting in a drop in their quick asset ratio.
56
Inventory Turnover
2002
2003
2004
2005
2006
Sara Lee
3.59
3.49
3.55
4.66
4.66
General Mills
4.24
5.31
5.82
6.15
6.20
Kraft
5.03
5.39
5.62
6.26
6.00
2002
2003
2004
2005
2006
Sara Lee
101.67
104.58
102.82
78.33
78.33
General Mills
86.08
68.74
62.71
59.35
58.87
Kraft
72.56
67.72
64.95
58.31
60.83
Days Supply of Inventory
Inventory turnover allows an analyst to examine how productively the
three principal components of working capital are being used. In assessing the
overall liquidity of a firm an analyst must take into consideration the amount of
inventory that is held by the firm. We believe this is an important consideration
since inventory is part of current assets. Therefore even if a firm shows a
favorable current ratio it could be deceiving if the firm is holding to much
inventory or failing to write of unusable inventory. Inventory turnover is found
by dividing the cost of goods sold (COGS) by a firms amount of inventory on
hand. Since inventory is part of current assets, it is important to decipher
between inventory and other current assets. If a firms inventory is too high in
relation to it’s COGS then the ratio may indicate that inventory levels do not
meet the required level to sustain a profitable business. A lower ratio can be
detrimental in some cases, but may also indicate that the company is
overstocking its inventory or delaying inventory write-offs in order to keep there
57
current assets high. Although Sara Lee’s ratio is smaller than General Mills and
Kraft, we feel that Sara Lee is turning over their inventory at an efficient level by
keeping their cost of goods sold at an appropriate level, relative to their
inventory levels.
Output
Inventory Turnover
7
6
5
4
3
2
1
0
Sara Lee
General Mills
Kraft
Industry Avg.
2002 2003 2004 2005 2006
Years
The graph above shows Sara Lees’ inventory turnover ratio compared to
the industry. Sara Lee has a lower inventory turnover ratio compared to General
Mills and Kraft over the entire five year time period. This is so, due to Sara Lees’
level of cost of goods sold staying quite constant at around $10 billion. Sara
Lees’ inventory levels also stayed quite constant around almost $3 billion over
the five year time period, causing the ratio to remain around an average ratio of
4.34. Kraft on the other hand has a high inventory turnover ratio due to an
increasing high level of cost of goods sold; while also maintaining a lower level of
inventory compared to Kraft and Sara Lee. General Mills is able to maintain a
ratio level above the industry average due to their low levels of inventory.
General Mills’ inventory ratio increases over the years due to an increase in cost
of goods sold. Since inventory turnover directly impacts working capital, Sara
58
Lees’ low levels of inventory turnover will ultimately result in a lower percentage
of working capital. This is not a positive outcome because it is showing that Sara
Lee is not turning it’s inventory into sales at a rate at which they should be;
displaying that cash is continuously being held in inventory, elongating the cash
to cash cycle.
Days Supply of Inventory
120
Ouput
100
Sara Lee
80
General Mills
60
Kraft
40
Industry Avg.
20
0
2002 2003 2004 2005 2006
Years
Compared to others in the industry, Sara Lee falls short of displaying a
prominent days supply of inventory. Days supply of inventory explains the
number of days that it takes a company to make an initial order of inventory,
until the time it takes to have to re-order a new batch of inventory. Along with
days receivables and days payables, days inventory is another way to evaluate
the efficiency of a firms working capital management (Palepu). The industry
average is high due to Sara Lees’ large numbers of days supply of inventory,
which is due to Sara Lee having smaller outcomes of inventory turnover than
General Mills and Kraft. This is showing that Sara Lee is not selling their
inventory quick enough, and is ultimately storing their inventory inefficiently.
59
Receivables Turnover
2002
2003
2004
2005
2006
Sara Lee
8.21
8.35
8.60
9.56
9.11
General Mills
7.87
10.72
10.96
10.87
10.82
Kraft
9.54
9.20
9.09
10.10
8.88
2002
2003
2004
2005
2006
Sara Lee
44.46
43.71
42.44
38.18
40.07
General Mills
46.38
34.05
33.30
33.58
33.73
Kraft
38.26
39.67
40.15
36.14
41.10
Days Sales Outstanding
Much like inventory turnover, receivables turnover is also a measure of
how effectively and efficiently a company is making use of their assets.
Receivables turnover is found by dividing sales by the accounts receivable
balance found on the balance sheet. If a firms ratio reveals a high number, then
the firm does not sell as much merchandise on credit and therefore could have
less risk of accounts defaulting. Whereas if the ratio is low, then the firm takes
on more risk of not collecting payments of goods sold on credit. This is
important to analyze in addition to sales volume alone since sales assumes that
accounts receivable will be collected. A firm with a consistent receivable
turnover ratio demonstrates the ability to collect on credit sales. But a firm with
a decreasing number shows that a growing amount of credit accounts is going
uncollected. Days sales outstanding is also much like days supply of inventory.
Days sales outstanding tells us the specific number of days that it takes to collect
cash from receivables. A lower ratio is considered more valuable, meaning that
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the company is collecting cash faster, causing actual and forecasted bad debt
expense to remain lower.
Receivable Turnover
12
Ouput
10
Sara Lee
General Mills
Kraft
8
6
4
Industry Avg.
2
0
2002 2003 2004 2005 2006
Years
As the table and graph above demonstrate, Sara Lee projects a lower
receivables turnover than others in the industry, including the industry average.
Sara Lee persistently maintains this lower ratio because of their lower sales,
while also maintaining receivables of a little over $1 billion. General Mills
revenues were much smaller in 2002 of around $7 billion, but increased to over
$11 billion in 2005; this enabled them to keep a higher ratio by allowing fewer
sales on credit, which in turn caused a lower accounts receivable. Kraft on the
other hand maintains a high ratio due to very high sales numbers and low
accounts receivable relative to their sales. While Kraft did have a higher
accounts receivable than both Sara Lee and General Mills, it only accounts for
about 10% of sales; Sara Lees’ remaining around 11% and General Mills only
around 9%.
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Days Sales Outstanding
50
Ouput
40
Sara Lee
General Mills
Kraft
30
20
Industry Avg.
10
0
2002 2003 2004 2005 2006
Years
Because days sales outstanding has an inverse relationship with
receivables turnover, it is obviously apparent that Sara Lee is going to have the
highest days sales outstanding in the industry, because of their lowest
receivables turnover in the industry. The above table and graph both
demonstrate that over the five years, it took Sara Lee an average of 41.77 days
to collect their receivables. With the average of the industry being 37.06 days,
this demonstrates that Sara Lee is not collecting receivables from sales on credit
in an efficient manner. Since Sara Lee is not collecting cash in an efficient
manner this affects the amount of cash that they could either re-invest in the
company or use to create more sales. This is obviously a downfall that Sara Lee
must deal with and must either decrease accounts receivable while holding sales
constant, or increase total sales relative to accounts receivable; if not this could
restrict them from potential sales in the future. General Mills maintains the
lowest average DSO ratio out of the industry due to their lower accounts
receivables relative to sales.
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Working Capital Turnover
2002
2003
2004
2005
2006
Sara Lee
-30.44
20.08
48.75
17.24
32.08
General Mills
-3.44
-39.65
24.17
-9.96
-3.93
Kraft
103.56
117.91
49.96
-59.75
-15.48
Working capital explains how well a company is using it’s working capital
to create sales. Working capital is found by subtracting current liabilities from
current assets. Then dividing sales by working capital will give you the working
capital turnover. This reveals how well a firm’s investment in there working
capital is used to generate sales. A high ratio can mean that the firm is able to
generate more sales with a lower amount of working capital. But, this ratio can
be misleading since, the reason for low working capital can have different
effects. For instance, if working capital is lowered due to an unjustifiable
increase in current liabilities or decrease in current assets, then that would show
an unfavorable impact on the firm.
Working Capital Turnover
150
Ouput
100
Sara Lee
General Mills
Kraft
50
0
-50
2002 2003 2004 2005 2006
Industry Avg.
-100
Years
63
Sara Lee is able keep a moderate working capital turnover ratio from 2002
to 2004. In 2002, Sara Lee produced a negative working capital turnover due to
their current liabilities remaining larger than their current assets by $477 million.
The jump from 2002 to 2003 was due to an increase in both sales and current
assets, with also a decrease in current liabilities. From 2002 to 2003, sales
increased around $400 million, while total current assets increased around $989
million. On the other hand, the decrease of total current liabilities of around
$231 million helped increase Sara Lees’ working capital turnover by 50.52. Sara
Lee was able to maintain an increase in their WCT ratio from 2003 to 2004 for
different reasons than the year before. From 2003 to 2004, Sara Lee increased
their sales by $973 million and actually decreased their total current assets by
$176 million; with an increase in current liabilities of $241 million as well. While
sales did increase, this can have a negative affect on Sara Lee if they continue to
increase their current liabilities by larger amounts in the future. Kraft’s ratio
drops from 2003 to 2005 due to a large increase of current assets of around
$2.27 billion over that two year time period. General Mills’ ratio decreased
significantly from 2002 to 2003, due to current liabilities outweighing current
assets by $2.3 billion. Compared to others in the industry, Sara Lee seems to be
maintaining a more efficient WCT over the five year period, due to their steady
increase in sales as well as their steady increase in currents assets over their
current liabilities.
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Liquidity Analysis
2002
2003
2004
2005
2006
Opinion
Current Ratio
0.91
1.14
1.06
1.19
1.08
Positive
Quick Ratio
0.38
0.54
0.47
0.44
0.63
Steady/Average
Inventory
3.59
3.49
3.55
4.66
4.66
Negative
101.67 104.58 102.82 78.33
78.33
Positive
8.21
8.35
8.60
9.56
9.11
Positive
44.46
43.71
42.44
38.18
40.07
Steady
-30.44
20.08
48.75
17.24
32.08
Moderate
Turnover
Days Supply
of Inventory
Receivables
Turnover
Days Sales
Outstanding
Working
Capital
Turnover
The liquidity analysis for Sara Lee was moderately positive, with only a
single factor in which we found to be negative. Sara Lee seemed to lead or rank
among the best with their current ratio, days supply of inventory and receivables
turnover. This shows that Sara Lee is able to meet their short term debt, as well
as collecting receivables at an efficient rate. Their days supply of inventory was
another positive aspect, which shows that the amount of time that it takes for
inventory to be ordered and re-shipped to customers is minimal, allowing them
to keep lower levels of stagnant inventory on hand. Sara Lee seems to have no
major problems with liquidity, but still contains room for improvement. Based on
65
the information provided, we believe that Sara Lee will continue to operate at the
same steady rate or possibly improve over the years to come.
Profitability Ratios
Profitability ratios help show the makeup of a firm’s overall ability to
generate earnings relative to their costs that they have incurred over a specific
time frame. These ratios break down into two categories. The first is operating
efficiency which is shown by gross profit margin, operating expense ratio, and
net profit margin. Operating ratios help show the amount of revenues generated
by a firm in contrast to the expenses incurred while conducting business. The
second category shows a firm’s return on its assets and equity as well as the
productivity of its assets. When comparing profitability ratios as a whole, you
must understand the type of industry that it is in and its possible seasonality
periods. For example, Sara Lee experiences higher revenues in the 2nd and 4th
due to the seasons of Christmas and summer. Since revenues tend to rise a
great deal during these time periods in a seasonal fashion, you would not
compare Sara Lee’s 2nd quarter profit margin to their 3rd quarter profit margin for
obvious reasons. Due to seasonality when dealing with profitability ratios, it is
apparent that one must compare the same time period to the year before in
order to help make a rational decision between the two time periods.
66
Gross Profit Margin
2002
2003
2004
2005
2006
Sara Lee
38%
38%
39%
37%
37%
General Mills
40%
42%
41%
39%
40%
Kraft
40%
39%
37%
36%
36%
Gross profit margin is found by dividing a firm’s gross profits by its total
revenues. This ratio is a good starting point in determining potential profitability
since it reveals the profitability of the products that a firm engages in selling,
given that gross profit only accounts for the cost of goods that are being sold as
an expense. Firms with a high gross profit margin will in turn have the potential
for high returns if they can keep there other costs low. Firms with a low gross
profit margin show that they engage in business with potentially low profits, and
may have a harder time in keeping expenses low enough to ultimately turn a
profit.
43%
42%
41%
40%
39%
38%
37%
36%
35%
34%
33%
Sara Lee
General Mills
Kraft
Industry Avg.
20
02
20
03
20
04
20
05
20
06
Ouput
Gross Profit Margin
Years
67
The above graph and table compare gross profit margin between Sara Lee
and other competitors in the industry. General Mills illustrates that they have the
highest gross profit margin in the industry due their lower revenues relative to
gross profit. General Mills maintained an average gross profit of around $4.2
billion, which was somewhat close to Sara Lee’s of $5.9 billion. Sara Lees’ ratio
is consistently lower than General Mills’ because of their difference in sales; From
2002 to 2006 Sara Lee having average sales of around $15.5 billion and General
Mills having sales around $10.5 billion on average. Kraft on the other hand,
having average sales of around $32.3 billion and gross profit of around $12.1
billion, is not able to compete with Sara Lee and General Mills because of their
high denominator; which is sales. Kraft continued to experience a decrease in
their ratio because of a 15% increase in sales from 2002 to 2006. General Mills
experienced a decrease in their ratio from 2004 to 2006 due to a larger increase
in sales than gross profit. Sara Lee did not see this type of decline until the
middle of 2004, when it experienced a 4.8% decrease in gross profit and an
0.3% increase in sales from 2004 to 2006.
Operating Expense Margin
2002
2003
2004
2005
2006
Sara Lee
29%
28%
30%
29%
30%
General Mills
24%
23%
22%
22%
23%
Kraft
19%
20%
21%
21%
21%
Operating expense ratio relates sales to the selling, general and
administrative expense (SG&A) incurred by a firm. A high operating expense
ratio could be due to an inefficient use of money and poor management
decisions. Since SG&A is one of the largest expenses taking away from profits, it
68
is crucial that a firm keeps it as low as possible while still striving for growth.
Sara Lee maintains a high OEM ratio compared to General Mills and Kraft, due to
their lower sales compared to Kraft and higher operating expenses compared to
General Mills.
35%
30%
25%
20%
15%
10%
5%
0%
Sara Lee
General Mills
Kraft
Industry Avg.
20
02
20
03
20
04
20
05
20
06
Ouput
Operating Expense Margin
Years
The above graph compares Sara Lee’s operating expense margin to
General Mills and Kraft, as well as the industry average. Sara Lee’s ratio stays at
such a high percentage because they maintained an operating expense near
Kraft’s of around $4 to $5 billion, while also maintaining around half of Kraft’s
sales of $14 to $16 billion. General Mills maintains both low operating expenses
and sales throughout the five year time period. The drop in General Mills’
operating expense margin from 2002 to 2004 was an effect of their SG&A
expenses increasing only around 26% compared to sales, which increased
around 39%. Kraft on the other hand is able to maintain the lowest operating
expense margin in the industry, solely due to their large revenues. Relative to
sales, Kraft’s SG&A expenses make up only 20% of their total revenues on
average; which is favorable when comparing them to Sara Lee, whose SG&A
69
expenses make up around 29% of their total sales on average, and General Mills,
whose SG&A expenses make up around 23% on average. Sara Lees’ high
operating expense margin signifies that a larger portion of their revenues are
going into their operating expenses, therefore leaving less cash to flow into net
income.
Net Profit Margin
2002
2003
2004
2005
2006
Sara Lee
7.0%
7.9%
8.0%
4.5%
3.5%
General Mills
5.8%
8.7%
9.5%
11.0%
9.4%
Kraft
8.5%
11.2%
8.3%
8.5%
8.9%
Net profit margin, or return on sales, shows the percentage of sales
revenues that are left after all expenses have been paid. It is calculated by
dividing net income by sales revenues. Firms with higher net profit margins than
competitors may have a cost leader or differentiation advantage in the industry
and therefore have a high potential for higher sustainable profits. Sara Lees
average net profit margin is around 6%, which mean that $0.06 of every dollar
of sales actually flows into net income. The above graph demonstrates that Sara
Lee contained a fairly high ratio in 2002 to 2004, but had a downfall after 2004.
70
Net Profit Margin
12.00%
Ouput
10.00%
Sara Lee
General Mills
8.00%
6.00%
Kraft
Industry Avg.
4.00%
2.00%
20
06
20
05
20
04
20
03
20
02
0.00%
Years
According to the cross sectional analysis graph above, Kraft manages to
have the highest net profit margin ratio up until after 2003. The decrease in
their ratio was due to a decrease in their net income of about 20%, and an
increase in their sales of 10%. From 2002 to 2005 General Mills continued to
experience an increase in both sales and net income. The cause for General
Mills’ decrease in their ratio from 2005 to 2006 was a decrease in their net
income of about 14%. Sara Lee experienced good growth in both net income
and sales from 2002 to 2004, after which they experienced a decrease in net
income of 56%. Due to this large drop in their net profit margin, Sara lee
became less and less of a competitor in cost leadership after 2004. The industry
average was quite stable up until 2003, after which it started to decrease rapidly,
resembling that of Sara Lee, Kraft and General Mills.
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Asset Turnover
2002
2003
2004
2005
2006
Sara Lee
1.06
0.96
1.07
1.12
0.69
General Mills
0.48
0.58
0.60
0.62
0.64
Kraft
0.52
0.52
0.54
0.59
0.62
Asset turnover is computed by dividing sales by assets in order to
determine the productivity at which a firm utilizes its assets. This ratio shows
the amount of sales dollars generated by each dollar of assets. Sara Lee
maintains a both stable and high asset turnover over the entire five year period.
Sara Lee’s average asset turnover was a 0.98, which is much higher than any
single year produced by General Mills or Kraft. General Mills asset turnover
increased steadily over the entire five years, due to a larger increase in their
sales relative to their total assets. While Kraft did hold an increase in their ratio
at a steady rate of around 0.56, they are restricted in turning out a higher ratio
due to the average value of their total assets being $57.9 billion.
Asset Turnover
1.20
Ouput
1.00
Sara Lee
General Mills
0.80
0.60
Kraft
Inustry Avg.
0.40
0.20
0.00
2002 2003 2004 2005 2006
Years
72
The above graph and table demonstrate the number of sales that Sara Lee
is able to generate off of each of their assets. For example, in 2005, Sara Lee’s
asset turnover is a 1.12, which indicates that for every asset they are able to
create $1.12 return in sales. The industry stayed quite steady over the entire
five years, not including 2002 to 2003, due to Sara Lee weighting the industry
down in their decrease from a 1.06 to a 0.96. This particular decrease was
caused by a large increase in their total assets of around $1.8 billion, relative to
their smaller increase in sales of $400 million. The graphs clearly demonstrate
that Sara Lee leads the industry in using their assets efficiently in order help
maximize the creation of sales dollars. Although Sara Lee did have a substantial
decrease in their asset turnover ratio from 2005 to 2006, which was caused by a
decrease in sales of 0.5% and an increase in total assets of almost 2%, they still
maintained a more efficient ratio than anyone in the industry.
Return on Assets
2002
2003
2004
2005
2006
Sara Lee
7.4%
7.6%
8.6%
5.0%
3.8%
General Mills
2.8%
5.0%
5.7%
6.9%
6.0%
Kraft
5.9%
5.9%
4.4%
5.0%
5.5%
The return on assets is a percentage that explains how much profit a
company returns for each dollar of its assets. A high return on assets is good for
a company. A firm should like to see a constant ROA or an increasing ROA.
73
Return on Assets
10.00%
Ouput
8.00%
Sara Lee
General Mills
6.00%
Kraft
Industry Avg.
4.00%
2.00%
20
06
20
05
20
04
20
03
20
02
0.00%
Years
A decreasing ROA like Sara Lee has is not desirable. This means they are
not receiving the same value from each dollar of assets that they were in the
past. The rest of the industry is moderately strong in this area. The graph
shows how the other players in the industry are increasing and Sara Lee is
decreasing significantly. Sara Lee’s total assets have stayed relatively constant
over the past five years, so their net income is the factor in this ratio which is
ultimately hurting them. If they could raise their level of net income they may
be able to improve their ratio altogether.
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Return on Equity
2002
2003
2004
2005
2006
Sara Lee
34.3%
56.4%
42.6%
26.3%
22.7%
General Mills
12.4%
20.5%
19.0%
18.2%
15.8%
Kraft
13.1%
12.2%
8.9%
9.8%
10.7%
Return on equity is the percentage of the equity that a firm is able to
produce. The basic formula is net income divided by owners equity, but can be
further decomposed as: net income/assets * assets/equity, or ROA multiplied by
financial leverage (Palepu). Firms with high returns on equity show the ability to
generate large profits with little investment from owners. Return on equity is
closely related to the return on assets, these numbers would in fact be equal if a
firm was financed through all equity (Palepu). A firm can increase its return on
equity by increasing its return on assets which will generate more profits to
equity holders, or by acquiring debt in order to finance the assets as long as it is
able to earn a higher return than the interest rate. Sara Lee has shown very
impressive returns on owner equity this is due to its extremely high debt ratio.
This allows them increase their asset base and also generate more profits
available to owners.
75
Return on Equity
60.00%
Ouput
50.00%
Sara Lee
General Mills
40.00%
30.00%
Kraft
Industry Avg.
20.00%
10.00%
20
06
20
05
20
04
20
03
20
02
0.00%
Years
According to graph above, Sara Lee’s ROE outperforms everyone listed in
the industry. Sara Lee is able to maintain this advantage due to higher net
income in relation to General Mills. Kraft is unable to compete with Sara Lee due
to their large amounts of owners’ equity in relation to net income. While Sara
Lee did experience a large decrease in their ROE after 2003, their ability to
manage their money efficiently enables them to remain ahead of the game.
76
Profitability Analysis
Gross Profit
2002
2003
2004
2005
2006
Opinion
38%
38%
39%
37%
37%
Steady
29%
28%
30%
29%
30%
Steady
7.0%
7.9%
8.0%
4.5%
3.5%
Negative
1.06
0.96
1.07
1.12
0.69
Negative
7.4%
7.6%
8.6%
5.0%
3.8%
Negative
34.3%
56.4%
42.6%
26.3%
22.7%
Negative
Margin
Operating
Expense
Margin
Net Profit
Margin
Asset
Turnover
Return on
Assets
Return on
Equity
Sara Lee’s profitability ratios have become quite negative over the five
year time period. There are only two ratios that have stayed steady over time,
(not improved), which are their gross profit margin and operating expense
margin. Since their profitability performance has declined over the years, this is
an indication that Sara Lee’s ability to generate revenues relative to their
expenses and other costs has decreased over the past five years. Based on the
information, we believe that Sara Lee will continue to fall behind in generated
revenues unless action is taken to revamp their numbers.
77
Capital Structure Ratios
Firms have two ways in order to finance their assets. One source of
financing is the use of equity which is capital provided by the firm’s owners. The
other available method of financing is through debt, which will be profitable and
increase the return on equity as long as the return on debt is higher than its
cost. Capital structure ratios analyze the way that a company structures the
financing its business, how these decisions effect profitability and the ability to
service its debt requirements. The three ratios we will use to analyze the capital
structure of Sara Lee and industry competitors are debt to equity, times interest
earned, and debt service margin.
Debt Service Margin
2002
2003
2004
2005
2006
Sara Lee
N/A
3.897
14.586
16.071
5.155
General Mills
2.14
4.88
5.89
1.53
1.28
Kraft
.83
4.05
4.76
4.47
2.81
The debt service margin is used to measure a firm’s ability to pay its debt
that is due within one year with its current cash flows. A margin of 5 for
example means that the firm as five dollars for every one dollar of debt due in
one year. An example of a bad margin would be Kraft’s numbers in 2002. With
the number less than one Kraft did not have enough cash flow to support their
payments on debt.
78
Debt Service Margin
18
16
14
12
10
8
6
4
2
0
Sara Lee
General Mills
Kraft
2002
2003
2004
2005
2006
Year
Sara Lee has a healthy debt service margin for the last few years. They
are actually well above the industry except for the year 2003. Sara Lee saw such
large increase in this margin in 2004 due to both a drop in notes payable and an
increase in cash flow. In 2005, cash flow actually decreased but notes payable,
which were due that year dropped dramatically. Sara Lee’s strong credit rating
was shown in July 1, 2006, when they paid out a $0.79 dividend/share, which
happens to be $0.07 more than their net income per share at $0.72. This shows
that Sara Lee has no contingencies prohibiting them from paying more dividends
than earnings. Since Sara Lee demonstrates a strong ability to pay off their
debt, this implies that Sara Lee would be able to take on more debt if they
choose to do so.
79
Debt to Equity
2002
2003
2004
2005
2006
Sara Lee
3.65
6.42
3.98
4.23
4.93
General Mills
3.44
3.04
2.33
1.65
1.64
Kraft
1.21
1.08
1.00
.95
.95
The debt to equity ratio relates a firms debt to their equity to show a firms
credit risk (class handout). A firm with a high debt to equity ratio has a higher
credit risk since there debt is high or equity is low in comparison. If the ratio is
above one then a firm uses more debt than equity to finance its assets and may
become a credit risk or even default if they are forced to liquidate. Having a
high debt to equity ratio can be beneficial if the return on debt is greater than
the interest paid. This implies that Sara Lee will be able to borrow at lower
costs, causing them to have a low interest risk.
Debt to Equity
7
6
3
Sara Lee
General Mills
Kraft
2
Industry Avg.
Ouput
5
4
1
0
2002 2003 2004 2005 2006
Years
80
In the graph above Sara Lee shows to have a significantly higher debt to
equity ratio than their competitors. In 2003 their ratio shot up to 6.42 mainly
due to a large increase in the firms long term debt balance of $4.36 billion in
2002 to $5.16 in 2003. In 2004 there ratio came back to their normal levels
since it’s long term debt fell to $4.17 billion. In 2006 Sara Lee’s ratio increased
again from 4.23 to 4.93 because of large increases in short term liabilities mainly
notes payable. Sara Lee has continually maintained a higher margin than
general mills and Kraft foods. While alarming, this ratio can be justified by Sara
Lee’s higher return on assets and return on equity. This indicates that they
efficiently use debt financing to increase overall returns on equity. Kraft for
example has maintained a lower and more consistent debt ratio but also has
lower returns.
Times Interest Earned
2002
2003
2004
2005
2006
Sara Lee
7.02
4.29
4.09
3.44
2.96
General Mills
7.15
7.47
8.35
9.86
12.74
Kraft
14.05
17.95
17.60
18.92
23.37
Times interest earned show a firm’s capabilities to pay interest charges
from both current and long term debt with its operating income. This ratio is
calculated by dividing operating income by its interest expense. A ratio that is
high shows adequate income to pay interest expenses while a low ratio shows
that a firm is not generating enough income from operations in relation to their
interest charges and may be in danger of defaulting on loans or receiving higher
interest rates on borrowing.
81
Times Interest Earned
25
Ouput
20
15
Sara Lee
General Mills
10
Kraft
Industry Avg.
5
0
2002 2003 2004 2005 2006
Years
The graph of times interest earned reveals that Sara Lee has a
substantially lower ratio than its competitors. Sara Lee’s ratio has also steadily
declined from 7.02 in 2002 to 2.96 in 2006. The very large decrease in 2006
was due to an increase in interest expense of $20 million from 2005 and a
decrease of operating income from $1.37 billion in 2005 to $911 million in 2006.
This drop in operating income is mainly accredited to the impairment charges of
$193 million incurred from its restructuring process. Kraft and General Mills
ratios are far higher than Sara Lee in 2006 with Sara Lee at 2.96, General Mills at
12.74 and Kraft at 23.37.
82
Capital Structure Analysis
2002
2003
2004
2005
2006
Opinion
N/A
3.897
14.586
16.071
5.155
Positive
Debt to Equity
3.65
6.42
3.98
4.23
4.93
Positive
Times interest
7.02
4.29
4.09
3.44
2.96
Negative
Debt Service
Margin
Earned
Sara Lee’s capital structure ratios have been quite positive over the years.
Sara Lee sees to have a very good credit rating by being able to pay back their
debts quickly. Although their debt to equity is higher than usual, Sara Lee is
financing their equity at an efficient manner. The only aspect that is negative is
their times interest earned. This was caused by decreases in their operating
income and increases in their interest expense. Overall, we believe that Sara Lee
is financing their operations in an efficient manner, allowing them lower their
borrowing costs and exceed their cost of capital.
Sustainable Growth Rate and Internal Growth Rate
The sustainable growth rate, commonly referred to as SGR, is defined as
being the rate at which a firm can grow while keeping its profitability and
financial policies unchanged (Palepu). This essentially means how much a
company can grow without taking on more equity. SGR equals the internal
growth rate multiplied by the difference of one and dividends paid divided by
equity (SGR=IGR(1-D/E)). The internal growth rate, commonly referred to as
IGR, is defined as being the rate at which a firm can grow without additional
financing (investopedia.com). IGR equals the return on assets multiplied by one
minus the dividend payout ratio (IGR=ROA(1-D/NI)).
83
SGR and IGR are positively related to one another. This means when IGR
goes up, SGR goes up and vice versa. SGR will also be higher than IGR due to
their mathematical relation. This is true except in the extremely rare instance
when IGR is negative. This occurred during year 2006 for Sara Lee. This
happened because the company paid more dividends than they had net income.
This causes the dividend payout ratio to be greater than one and thus causing a
negative IGR. For Sara Lee to pay more dividends than net income for that
particular year they had to reduce retained earnings. This practice allows a
negative growth rate to make sense. This also means that Sara Lee had to
acquire more debt to just have a 0% growth rate.
Sara Lee’s growth rates have dropped every year since 2003. This is not
a good quality. This means that the company must borrow more and more
money each year to keep a constant growth rate. This can be seen on the
company’s financial statements. They have the highest current liabilities in the
last five years for 2006, and their total liabilities are the highest since year 2003.
Sara Lee must improve this situation if they want to stay profitable. If they
continue with the decreasing growth rate trend they will spiral into massive debt.
The chart below shows the SGR and IGR for Sara Lee and its competitors.
84
IGR
2002
2003
Sara Lee
3.84%
4.37%
Kraft
General Mills
2004
2005
2006
3.75% 1.78%
-0.76%
4.27%
4.05% -0.94% 2.53%
2.69%
-4.29%
-1.11% -0.40% 0.59%
2.90%
SGR
2002
2003
2004
2005
2003
Sara Lee
4.47%
5.41%
4.65%
2.08%
-0.96%
Kraft
4.12%
3.90%
-0.90%
2.41%
2.54%
-2.95%
-0.83%
0.08%
0.49%
2.66%
General Mills
As the chart shows, Sara Lee’s competitors have been improving their
growth rates while Sara Lee’s has been decreasing in the most recent years.
Obviously as shown by General Mills, a negative IGR and SGR does not mean
doom, but Sara Lee needs to stay away from negative years like they had in
2006.
Forecasted Financial Statements
In forecasting Sara Lee’s financial information we used industry averages
and financial ratios in order to accurately forecast this data. Most firms that
demonstrate a competitive advantage over competitors will tend to lose it and
revert to industry averages over time. Since this forecast is for 10 years we
made gradual adjustments to account for such circumstances. Also, some ratios
such as asset turnover tend to remain consistent over time and forecast have
been made to reflect these trends. The income statement and balance sheet
were forecasted to show dollar amounts as well as in common size form to show
85
percentages and better communicate the trends and make up of the firms
financial status.
Income Statement
In the forecast of the income statement we used trends set by Sara Lee
and its competitors to try to accurately predict future revenues and expenses.
To forecast future net sales we found an average sales growth of Sara Lee and
competitors for years 2002 through 2006. With this information showing that
sales tend to grow at an average rate of 4% per year, which is the rate that was
forcasted. We feel that this is a reasonable estimate given the highly
competitive nature of the industry and small chance to gain market share. The
previous financial statements indicated that the Hanes segment consistently
accounted for approximately 4 billion dollars of revenues a year. A major
adjustment was made to the starting forecast year to decrease sales in order to
account for the spin off of the branded apparel segment which had no effect on
2006 or previous years.
For future estimates of cost of goods sold we predict them to stay at a
constant rate of 61% of total sales revenue given that this was consistent trend
for the past 5 years. For the forecast of SG&A we started with a slightly lower
percentage of sales than average due to restructuring efforts which already
showed a slight decrease and is expected to take full effect in 2007 and continue
for the foreseeable future. At this point we have an operating income of 10.8%
of net sales. This percentage is consistent with industry averages and should
give accurate estimates given the maturity of this industry. We estimated that
the interest expense would stay at a constant rate of 2.1% of total liabilities and
that interest income would be 4.1% of accounts receivable, leaving the income
from operations, net of tax, at 9.5% of sales. We assumed a constant tax rate
of 35% which was the most logical choice given past information. Given all this
86
information we believe that Sara Lee will generate a net income of 7.2% of net
sales a slightly higher rate than it did in 2005 and 2006. We believe this to be a
logical conclusion given the recent restructure and trends to move toward
industry averages. We feel that based on analysis of competition, competitive
advantage and financials of the firm and industry that these are reasonable
estimates of future earnings.
INCOME STATEMENT
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
14519
14919
15892
16029
15944
11806
12278
12769
13280
13811
14364
14938
15536
16157
16804
4% growth
rate
COGS
9001
9249
9684
10024
10023
7333
7626
7931
8249
8579
8922
9279
9650
10036
10437
62.1% of sales
GROSS INCOME
5518
5670
6208
6005
5921
4473
4652
4838
5032
5233
5442
5660
5886
6122
6367
37.9% of sales
SG&A
4245
4212
4811
4663
4843
3188
3315
3448
3586
3729
3878
4033
4195
4362
4537
27% of sales
OPERATING INCOME
1242
1458
1485
1369
911
1273
1324
1376
1432
1489
1548
1610
1675
1742
1811
INTEREST EXPENSE
177
340
270
288
308
214
222
231
240
250
260
270
281
292
304
10.8% of sales
2.1% of total
debt
INTEREST INCOME
80
80
80
90
80
62
64
67
69
72
75
78
81
84
88
1022
1023
1295
1180
683
1122
1165
1212
1261
1311
1363
1419
1475
1534
1595
9.5% of sales
126
(47)
244
99
273
392
408
424
441
456
477
496
516
537
558
35% tax rate
NET REVENUES
INCOME PRE-TAXES
INCOME TAXES
INCOME CONT OPS
NET INCOME
4.1% of A/R
896
1070
1051
1081
410
730
757
788
820
855
886
923
959
997
1037
6.2% of sales
1010
1174
1272
719
555
841
875
910
946
984
1024
1065
1107
1151
1198
7.1% of sales
87
Balance Sheet
For forecasts of the balance sheet we started by predicting that Sara Lee
would maintain a return on assets of 6.8% this was found by taking averages of
Sara Lee and its competitors from 2002 to 2006. Sara Lee’s make up of
financing for assets has been comprised mainly of debt in years 2002 through
2006 causing them to have a much higher return on equity than their
competitors we forecasted that this would slowly decline back to industry norms
over the next 10 years. We used a starting point of 21.9% of assets financed
through equity and ended in 2016 with 36% of assets financed by equity as
shown on the common sized balance sheet. This number was forecasted by
adding the difference of net income and dividends paid to the previous book
value of equity. For current and long term assets and liabilities we set them
equal to the past averages of Sara Lee’s current ratios. We feel that these will
prove accurate since they have been somewhat constant and should remain
necessary in order to maintain sales volumes. Asset balances such as accounts
receivable were calculated at 12.5% percent of net sales. Inventories were
taken at a percentage of the cost of goods sold with an adjustment from 2007 to
2011 to bring Sara Lee’s inventory turnover margin from 4.9 to approximately 6
then kept steady after that. We feel that this decrease in inventory is justified by
industry norms and the recent restructuring efforts. Other small items within the
current and long term assets and liabilities that were thought to be forecastable
were also forecasted at a percentage of their larger account found within the
common sized statement.
88
BALANCE SHEET
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
298
1004
655
533
2231
1476
1608
1744
1886
2030
2113
2198
2284
2377
2472
Assets:
Cash and equivalents
11.9% to 14%
Accounts receivable
1768
1787
1848
1677
1750
1476
1535
1597
1662
1727
1797
1869
1943
2022
2102
11.9%
Inventories
2509
2652
2728
2151
2153
1490
1478
1466
1454
1440
1499
1559
1620
1686
1753
12.1% to 10%
341
359
380
410
301
7
110
125
1172
339
4923
5912
5736
5943
6774
4570
4754
4945
5146
5347
5564
5787
6015
6260
6509
36.9%
118
Other current assets
Assets of discont operations
Total current assets
Other noncurrent assets
192
281
143
117
4
453
281
53
91
176
195
148
130
135
127
132
137
142
148
154
160
167
173
180
Buildings and improvements
1744
1895
2030
1712
1795
1552
1615
1680
1748
1816
1890
1966
2043
2126
2211
Machinery and equipment
4299
4872
5045
4367
4531
3929
4088
4252
4425
4598
4784
4976
5172
5382
5597
320
289
382
204
258
236
246
255
266
276
287
299
311
323
336
Accumulated depreciation
3384
3939
4269
3577
3777
3251
3382
3517
3660
3803
3958
4116
4279
4453
4631
Property, net
3155
3312
3236
2836
2942
2573
2677
2784
2897
3010
3133
3258
3387
3524
3665
Trademarks and intangibles,
2106
2058
1977
1395
1185
Goodwill
3314
3331
3354
3018
3052
0
149
152
938
360
13694
15496
14879
14300
14522
12368
12868
13382
13926
14471
15059
15662
16279
16941
17618
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Deferred tax asset
Land
Construction in progress
Assets of discont. operations
Total Assets
21.3%
2.2%
assume 6.8%
ROA
Liabilities and Equity
Notes payable
468
140
84
239
1784
435
445
454
463
470
477
483
487
490
491
Accounts payable
1359
1314
1293
1115
1226
1058
1082
1105
1126
1144
1161
1175
1185
1192
1194
Payroll and benefits
1147
1193
1150
929
996
421
439
531
431
475
Taxes other than payroll
102
111
119
87
79
Income taxes payable
122
22
247
142
253
Advertising and promotion
Other
Current maturities lt debt
1047
900
829
774
790
734
1004
1070
380
368
Liabilities of discont operations
0
46
87
916
306
298
305
311
317
322
327
331
334
336
336
Total Current Liabilities
5400
5169
5410
5013
6277
4646
4752
4850
4945
5024
5100
5161
5204
5235
5243
Long-term debt
4357
5157
4171
4112
3807
Pension obligation
Other liabilities
220
1178
870
766
436
1325
1496
1362
1410
1417
68
Liabilities of discont operations
0
18
7
206
Minority interest in subsidiaries
632
356
74
61
68
10746
13413
11894
11568
12073
9652
9851
10053
10249
10429
10614
10796
10950
11126
11272
2948
2083
2985
2732
2449
2716
3016
3229
3678
4042
4445
4866
5330
5815
6346
13694
15496
14879
14300
14522
12368
12868
13382
13926
14471
15059
15662
16279
16941
17618
Total Liabilities
Total Common Equity
Total Liabilities and
Equity
dec liab 17%
inc equity 17%
89
Statement of Cash Flows
After forecasting the balance sheet and income statement we used a
straight forward method of constructing the statement of cash flows from items
that we found forecast able in the other two statements. By using this method
in forecasting the operating segment of the cash flow statement we feel that we
have reached an accurate forecast of cash from operating activities. This is due
to the fact that Sara Lee has demonstrated a fair amount of consistency in their
operations over the analyzed years and we do not expect any major changes to
occur in this industry. We also feel that changes made to bring Sara Lee to
industry norms and reflect the recent restructuring attempts are accurate. Items
that were able to be forecasted have shown little impact in the past and should
not cause the forecasts to be greatly effected. Upon examining the investing
and financing sections of the statement of cash flows we determined that they
were to volatile for prediction, and any forecasts made could not be relied upon
to give an accurate view of future cash flows.
90
STAEMENT OF CASH FLOWS
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
719
555
841
875
910
947
984
1024
1065
1107
1152
1198
-117
-114
2002
2003
2004
1010
1187
1272
0
0
-119
Depreciation & Depletion
471
525
561
570
541
Amoritization of Intangible Assets
111
136
173
181
160
Impairment
0
0
0
350
587
net gain on bussiness dispositions
0
-16
14
-69
-589
112
Net Income / Starting Line
less: contingent sale proceeds
Deferred Income
2005
21
5
166
186
0
42
149
60
57
Dec(Inc) In Receivables
93
94
-44
-199
-14
274
-59
-62
-65
-65
-70
-72
-74
-79
-80
Dec(Inc) In Inventories
304
-23
-45
8
108
663
12
12
12
14
-59
-60
-61
-66
-67
7
-17
44
-9
-65
168
-24
-22
-22
-18
-17
-14
-10
-7
-2
1978
other
Dec(Inc) In Other Assets/Liabilities
Inc(Dec) In act payable
Inc(Dec) In Other Accruals
CFFO
Capital Expenditures
Net Assets From Acquisitions
Disposal Of business investments
--
-126
45
0
-10
27
0
-174
-330
-96
1735
1824
2042
1350
1232
89
1600
1659
1694
1783
1711
1774
1839
1907
669
746
-530
-538
-625
251
-68
-70
-74
-74
-80
-82
-84
-90
-92
1930
-10
0
-2
-78
369
-104
-107
-113
-113
-122
-125
-128
-138
-141
136
0
137
86
868
602
-159
-164
-173
-173
-187
-192
-196
-210
-215
CFFI
2475
-674
-184
-233
365
1222
-331
-340
-360
-360
-389
-399
-409
-438
-447
FCF
4210
1150
1858
1117
1597
1311
1269
1319
1334
1423
1322
1375
1430
1469
1531
0
98
139
161
27
Proceeds From Sale Stock
Com/Pfd Purchased
138
-555
-350
-396
-561
1362
1773
1
339
37
Reduction In Long Term Debt
503
-995
-1288
-1033
-467
Inc(Dec) In Short Term Borrowings
124
-359
-19
178
1528
Long Term Borrowings
Other Sources - Financing
0
0
0
0
33
Cash Dividends Paid - Total
484
-497
-714
-464
605
CFFF
470
-535
-2231
-1215
-8
91
Cost of Capital
There are three main areas of cost of capital: weighted average cost of
capital, cost of debt, and cost of equity. Cost of capital is crucial in estimating
the value of a firm. Models that use cost of capital information are the
discounted dividends, residual income, abnormal earnings growth, free cash
flows, and long run return on equity. In order for us to perform correct
estimations of the value of Sara Lee, it is crucial that we perform the cost of
capital calculations accurately.
WACC
WACC is the starting point for many valuation models. It is crucial to the
valuation process. The formula for WACC is as follows:
WACC= (Vd/Vf)(Kd)(1-T) + (Ve/Vf)(Ke)
The value of debt (Vd) is simply the book value of debt. Sara Lee’s total
liabilities are $12,073 million. The value of equity (Ve) is the market value of
equity. This is the market capitalization. Market capitalization is the number of
outstanding shares times the current price per share. Sara Lee’s market
capitalization is $12,359 million. The market value of the firm is found by adding
together the market values of the equity and debt. Sara Lee’s firm value is
$24,432 million. We chose to use a 35% tax rate for our valuations and
forecasting due to historical trends. When the numbers for the WACC are
inserted in a weighted average cost of capital of 6.07% is found. The cost of
debt and the cost of equity will be explained in the next two paragraphs.
92
Cost of Debt (Kd)
To find the cost of debt for Sara Lee we had to give discount rates to each
of the liabilities on the balance sheet. The long-term liabilities were broke down
well in Sara Lee’s 2006 annual report filed with the SEC. Using weighted
averages we calculated the long term discount rate. Below are a few examples
of how the long-term liabilities were broken down. The chart shows the type of
liability, interest rate on the liability, amount of the liability, and a its percentage
of total liabilities. (Please see the appendix for fully disclosed information on this
subject.) The short-term and current liabilities were broke down into categories
and given rates based on treasury bills. We found these rates on the St. Louis
Federal Reserve website. Then we used weighted averages based on the
percentage of each specific liability in the total debt to find the cost of debt. We
found the cost of debt to be 5.53%.
6.125% Notes
6.13%
759
1.22%
11.35%
34
0.10%
notes
6.28%
252
0.42%
2.75% Notes
2.75%
300
0.22%
7.05-7.40% Notes
7.23%
75
0.14%
6.5% Notes
6.50%
150
0.26%
11.35% Mex. Pesos
5.6-6.95% medium
Cost of Equity (Ke)
Cost of equity is essential in determining the residual income model,
discounted dividends, abnormal earnings growth, and the long run ROE
perpetuity. We had to run regressions on numerous data sets to determine the
accurate beta and risk free rate. To solve for cost of equity we used the CAPM
model. The CAPM model (with determined information) is as follows:
93
Ke = Risk Free Rate + Beta*Market Risk Premium
Ke = 5.16% + .6550(5.08%)
Ke= 8.488%
To get the necessary information for this model we had to use various
market data. We observed monthly pricing data for treasury bills and the
monthly share prices for Sara Lee. We compared these rates with the rates from
the S&P 500 index. We chose to use the 3 month Treasury bill to do our
observations with due to its high adjusted r squared figure. The higher the r
squared for an observation the more relevant it is to determining future values.
Based on our calculations we derived a market risk premium of 5.08%. We feel
this is a sound MRP for the market. The beta of .655 was found by comparing
stock performance of Sara Lee with that of the market. This beta is even
actually very close to other current estimates done by other analysts in the
market (e.g. yahoo.com/finance). This gives us even more confidence that the
beta is accurate. The tables below show a summary of this information.
Cost of Equity Estimations:
10 Year
Months
Beta
(Rf =
R^2
5.92%)
Ke
7 Year
(Rf =
4.71%)
Months
Beta
R^2
Ke
72
0.3247
0.0485
0.0777
72
0.3217
0.0478
0.0616
60
0.6521
0.1831
0.0964
60
0.648
0.1814
0.0763
48
0.4693
0.0581
0.086
48
0.4659
0.0566
0.0681
36
0.5983
0.1078
0.0934
36
0.5929
0.1065
0.0738
24
0.6479
0.0986
0.0962
24
0.6456
0.0991
0.0762
94
Months
5 Year
(Rf =
Beta
R^2
4.71%)
Ke
1 Year
(Rf =
5.05%)
Months
Beta
R^2
Ke
72
0.3225
0.0481
0.0617
72
0.3244
0.0488
0.0665
60
0.6496
0.1823
0.0766
60
0.6545
0.1845
0.0829
48
0.4677
0.0575
0.0683
48
0.4738
0.0602
0.0739
36
0.5973
0.1082
0.0742
36
0.6126
0.1141
0.0808
24
0.6444
0.0987
0.0764
24
0.6399
0.0958
0.0822
3 Month
(Rf =
Months
Beta
R^2
5.16%)
Ke
72
0.3236
0.0485
0.068
60
0.655
0.1846
0.0849
48
0.4749
0.0604
0.0757
36
0.6136
0.1142
0.0828
24
0.6382
0.0947
0.084
Valuations
Several common models are used to determine the intrinsic value of Sara
Lee. We use the method of comparables, discounted dividends model,
discounted free cash flow model, abnormal earnings growth model, residual
income model, and the long-run ROE/RI model. These models all have various
components that include figures such as earnings, dividends paid, cost of equity,
weighted average cost of capital, and growth rates. The most reliable model is
the residual income model. It is most reliable because of the use of benchmark
earnings, also known as normal earnings. This gives the model stability in the
perpetuity. The dividend model and the cash flow model are not as reliable, so
we do not put as much value in their estimates for Sara Lee. The method of
comparables is more or less a good screening tool to get a quick snapshot of
Sara Lee. Overall, these models show that Sara Lee is an overvalued firm.
95
Method of Comparables
2006
PPS
EPS
BPS
DPS
SLE
16.02
0.72
3.22
0.79
GIS
51.79
3.05
16.12
1.34
KFT
35.70
1.86
17.45
0.96
The Method of Comparables valuation method is quick and easy screening
tool, that helps explain the value of an asset based on the most recent historical
data. This particular valuation method can be somewhat unreliable, since the
accuracy of the comparables largely depends on the industry average. This can
be a problem because some of the figures are not applicable due to their
negative value, causing vital information to be left out in helping us value Sara
Lee. Although, in some instances, these valuation methods due provide
unreliable measures, they are still a valuable tool in comparing Sara Lee to its
competitors.
SLE SHARE PRICE
P/E 2006
P/E 2005
P/B
P/S
D/P
PEG
$13.02
$14.22
$8.47
$35.38
$2.93
$13.32
96
Forward P/E (2006)
SLE
GIS
KFT
PPS
EPS
P/E
$16.02
$51.79
$35.70
$0.72
$3.05
$1.86
$22.25
$16.98
$19.19
IND. AVG
SLE PPS
$13.02
$18.09
In estimating Sara Lee’s share price using the P/E valuation method, you
must start by multiplying the competitor’s price per share by their earnings per
share. After taking an industry P/E average, you then multiply this by Sara Lees
earnings per share.
This calculation will in turn give us Sara Lee’s current
forward share price.
In this instance, Sara Lee’s share price is $13.02.
In
comparing it to their own price per share of $16.02, this implies that Sara Lee is
an overvalued company.
Trailing P/E (2005)
SLE
GIS
KFT
PPS
EPS
P/E
$19.65
$49.68
$28.17
$0.91
$3.34
$1.72
$21.59
$14.87
$16.38
IND. AVG
SLE PPS
$14.22
$15.63
In calculating the trailing P/E ratio, you use the same methods that you
used in calculating the forward P/E ratio. You start out by multiplying the
competitor’s price per share by their earnings per share. You then take an
industry P/E average and multiply this by Sara Lee’s earnings per share. The
only thing that different about the trailing P/E ratio and the forward P/E ratio, is
that for the trailing P/E ratio you use previous year data; hence “trailing” P/E.
This particular valuation insists that Sara Lee is undervalued by $5.43; actual
price being $19.65 and valued price being $14.22.
97
Price to Book P/B
SLE
GIS
KFT
PPS
BPS
P/B
$16.02
$51.79
$35.70
$3.22
$16.12
$17.45
$4.98
$3.21
$2.05
IND. AVG
SLE PPS
$8.47
$2.63
In calculating price to book, you divide price per share by the book value
per share for each of the competitors. After this, you find an industry average in
which you will multiply by Sara Lee’s book value per share. This particular ratio
states that Sara Lee is overvalued, with a price at $16.02. The ratio indicates
that Sara Lee’s share price should be $8.47, which would be a reasonable price if
Sara Lee’s return of equity was not as high and more like the industry norm.
Price to Sales P/S
SLE
GIS
KFT
PPS
SPS
P/S
$16.02
$51.79
$35.70
$20.81
$32.51
$19.81
$0.77
$1.59
$1.80
IND. AVG
SLE PPS
$35.38
$1.70
Calculating the price to sales ratio is much like calculating the price to
earnings and market to book ratio. You start out by dividing the competitor’s
price per share by their sales per share, and then add them up to take an
industry average. We then multiplied the industry average by Sara Lee’s sales
per share to get their estimated share price of $35.38. This ratio insists that
Sara Lee is undervalued by $19.36.
98
Dividend/Price D/P
SLE
GIS
KFT
PPS
DPS
D/P
$16.02
$51.79
$35.70
$0.79
$1.34
$0.96
$0.49
$0.26
$0.27
IND. AVG
SLE PPS
$2.93
$0.27
The dividend to price valuation displays that Sara Lee’s estimated share
price should be $2.93. According to this Sara Lee is overvalued by $13.09, with
their actual price being $16.02. In finding D/P, you divide the dividend per share
by price per share, for all competitors. After taking the industry average we
divided Sara Lee’s dividends per share by the industry average in order to get an
estimated share price.
Price Earning Growth (P.E.G)
SLE
GIS
KFT
PPS
EPS
G
PEG
$16.02
$51.79
$35.70
$0.72
$3.05
$1.86
4.0%
7.5%
5.0%
$23.18
$18.36
$20.20
IND. AVG
SLE PPS
$13.32
$19.28
In finding Sara Lee’s price earnings growth, we started out by finding the
competitor’s P/E ratio. After finding this, we divided their P/E ratio by
(1-growth rate). After taking an industry average we multiplied the industry
average by (1-growth rate), times Sara Lee’s earnings per share. With an
share value of $13.32, this valuation model suggests that Sara Lee is overvalued
at $16.02 per share.
99
Discounted Dividends Valuation Model
The discounted dividends model is a method to value the equity of a firm.
In this process the present value of all forecasted dividend payments is found to
be the current market value of shareholder equity. This valuation model is
relevant since all future dividends to shareholders in the form of cash payoffs
represent the value of equity relative to the firms cost of capital. In order to
forecast the future dividends for Sara Lee we reviewed dividend payoffs for the
previous 10 years, this revealed a steady trend in the amount of dividends paid
each quarter. From this we derived that in 2007 dividend payout would total
$575 million and increase $0.03 per share every other year until reaching a
perpetuity payment amount of $666 million in 2017.
After forecasting the dividends we used the cost of equity that we found
to be 8.4% to discount back forecasted dividend payments back to present value
terms. We found the present value of all forecasted dividends from 2007 to
2016 to be $4025 million. The present value of the perpetuity starting in 2017
has an estimated value of $4548 million. This value was found using an 8.4%
cost of equity capital and a dividend growth rate of 2%. This valuation gave an
intrinsic present value of $8573 million as of April 1 2007. This gives a per share
value of $11.24. This valuation would indicate that Sara Lee is overvalued given
that the market price per share of $16.92. In the sensitivity analysis of Sara lee
estimations of stock value ranged from $14.06 given a 0% growth rate and 6%
cost of equity, to $10.43 with a 2% growth rate and a 9% cost of equity. This
valuation does hold some validity in the estimation of stock price given the
consistency of payoffs Sara lee has maintained over the previous years. On the
other hand this model could be misleading given that it does not take into
account the amount of money that is reinvested into the firm in other methods
that could add value to the firm.
100
Discounted Dividends Sensitivity Analysis
g
Ke
0.00
0.01
0.02
0.03
0.04
0.06
$14.06
$15.68
$18.12
$22.17
$30.30
0.07
$12.00
$13.05
$14.54
$16.75
$20.35
0.085
$9.84
$10.45
$11.24
$12.33
$13.91
0.09
$9.27
$9.78
$10.43
$11.32
$12.54
0.10
$8.31
$8.68
$9.15
$9.75
$10.56
Undervalued
Overvalued
Discounted Free Cash Flow Valuation Model
In the cash flow valuation model for Sara Lee we forecasted out free cash
flows to the firm of $1311 million in 2007 through 2016 with a free cash flow of
$1531 million. Free cash flows are made to all of the firm’s assets whether
funded by debt or equity. Therefore we used Sara Lee’s weighted average cost
of capital (WACC) of 6.07% to discount future free cash flows back to present
value of ending fiscal year 2006. We found the value of forecasted cash flows to
assets from 2007 to 2016 to be $10,027 million. Then we found that the
perpetuity payment of $1608 in 2017 to grow at a rate of 2 % giving a present
perpetuity value of $21,910 million as of 2006. Then by adding our present
values together and taking out the value of debt we were able to derive a
intrinsic share price of $25.93 as of July 31, 2006 or $26.02 at April 1, 2007 in
which would indicate that Sara Lee is under valued with a stock price of $16.92.
Prices in the sensitivity analysis range from $140 per share to $8.37. Since, cash
flows are hard to predict, and this model does not do very well to explain
variations in stock price due to variations in the future free cash flows. The fact
101
that it shows the intrinsic value to be much higher than the value provided by
the discounted dividends and residual income models makes an argument that
this valuation method may not be accurate.
Free Cash Flows Sensitivity Analysis
g
WACC
0
0.01
0.02
0.03
0.04
0.04
$34.28
$46.11
$69.79
$140.84
N/A
0.05
$23.88
$30.33
$41.09
$62.63
$127.23
0.061
$16.57
$20.36
$26.02
$35.37
$53.75
0.07
$12.05
$14.60
$18.16
$23.52
$32.45
0.08
$8.37
$10.11
$12.45
$15.70
$20.58
Undervalued
Overvalued
Residual Income Valuation Model
The residual income valuation method measures net income against a
future benchmark of earnings to find the residual income, and then discounts the
residual income to a present value. For this valuation we used forecasted values
for net income from the income statement, the book value of equity from the
balance sheet, and our forecasted dividend values from the dividends model.
The benchmark earnings were found by multiplying the previous BVE by the cost
of equity, which was found to be 8.4%. The present value of forecasted earning
from 2007 to 2016 equaled $4,185 million. A perpetuity residual income $659
million with a negative growth rate of 30% revealed a present terminal value of
$336 million. Along with a current book value of equity of $2449 million the total
present value was $6,970 million. The intrinsic share price was found to be
$9.10 per share as of July 31, 2006 and $9.44 as of April 1, 2007. These values
102
indicate that Sara Lee is currently overvalued with a current market price of
$16.92. in the sensitivity analysis the values ranged from $8.90 to $11.40 all of
which indicating a substantial overvaluing in the market. We believe this to be a
fair estimate given its consistency with the discounted dividends and abnormal
earnings models.
Residual Income Sensitivity Analysis
g
Ke
(0.10)
(0.20)
(0.30)
(0.40)
(0.50)
0.06
$12.00
$11.47
$11.24
$11.11
$11.02
0.07
$11.10
$10.66
$10.46
$10.34
$10.27
0.085
$9.92
$9.59
$9.44
$9.34
$9.28
0.09
$9.56
$9.26
$9.11
$9.02
$8.96
0.1
$8.90
$8.65
$8.52
$8.44
$8.39
Undervalued
Overvalued
Abnormal Earnings Growth (AEG) Model
This valuation model is second only to the residual income valuation
model in terms of dependability. It does a good job at valuing a firm. It relies
on earnings and dividends to create a valuation. Like residual income,
benchmark earnings (also called normal earnings) are used as a basis in the
model. Normal income is found in this model by multiplying earnings by the one
plus the cost of equity. This creates a more reliable valuation than the free cash
flow and discounted dividends models that do not have any stable benchmark to
follow. Shown below is the sensitivity analysis we created when using the AEG
model.
103
AEG Sensitivity Analysis
g
Ke
(0.10)
(0.20)
(0.30)
(0.40)
(0.50)
0.06
$8.82
$7.92
$7.51
$7.28
$7.13
0.07
$8.61
$7.80
$7.42
$7.21
$7.07
0.085
$8.33
$7.63
$7.29
$7.09
$6.96
0.09
$8.24
$7.57
$7.25
$7.06
$6.92
0.1
$8.07
$7.46
$7.16
$6.98
$6.86
Undervalued
Overvalued
We used negative growth rates when performing the AEG model. This
provides a more reliable valuation than using positive growth rates. To use a
positive growth rate would be unrealistic and almost impossible to achieve in a
real world context.
As the chart above clearly states this model highly suggests that Sara Lee
is overvalued. The actual share price of Sara Lee is $16.92 as of April 1, 2007.
The closest estimation on the chart to $16.92 is $8.82, which is achieved with a
6% cost of equity and a -10% growth rate. That is a difference of $8.10 per
share. It should be noted that the original valuations we arrived at were valued
as of July 31, 2006, which is the fiscal year end for Sara Lee. To compensate for
the eight month gap between July 31 and April 1 we had to pull our numbers
forward appropriately. The chart above reflects these changes. Based on this
model Sara Lee is overvalued and the stockholder recommendation would be to
sell.
104
Long Run Return on Equity Perpetuity
This model is another valuable way to determine the worth a company.
The formula for the perpetuity is as follows.
Po = BVE(1 + (ROE-Ke)/(Ke-g))
As shown by the formula, the valuation this model provides is determined
by four components: book value of equity (BVE), return on equity (ROE), cost of
equity (Ke), and growth rate (g). Due to this fact we have ran the model using a
wide variety of different possibilities, with the only constant variable being the
book value of equity. The charts below show this strategy.
Ke
g
0.06
0.07
0.08488
0.09
0.10
0
12.18
10.44
8.61
8.12
7.31
0.01
13.97
11.65
9.33
8.73
7.76
0.02
16.66
13.33
10.27
9.52
8.33
0.03
21.14
15.86
11.56
10.57
9.06
0.04
30.11
20.07
13.42
12.04
10.04
Undervalued
Overvalued
*ROE=22.7%
ROE
g
0.10
0.15
0.227
0.25
0.30
0
3.79
5.69
8.61
9.48
11.38
0.01
3.87
6.02
9.33
10.32
12.47
0.02
3.97
6.45
10.27
11.41
13.90
0.03
4.11
7.04
11.56
12.91
15.84
0.04
4.30
7.89
13.42
15.07
18.65
Undervalued
Overvalued
*Ke=8.488%
105
Ke
ROE
0.06
0.07
0.08488
0.09
0.10
0.1
6.44
5.15
3.97
3.68
3.22
0.15
10.47
8.37
6.45
5.98
5.23
0.227
16.66
13.33
10.27
9.52
8.33
0.25
18.52
14.81
11.41
10.58
9.26
0.3
22.54
18.03
13.90
12.88
11.27
Undervalued
Overvalued
*g=2%
These charts clearly show that this model provides overwhelming
evidence that Sara Lee is overvalued. The actual share price of Sara Lee is
$16.92. There are only seven instances out of seventy-five instances that this
model gives an undervalued estimation. It should be also noted that those
seven instances are all at the extreme ends of the charts, which makes the
possibility of them being accurate very slim. Based on this valuation alone, Sara
Lee’s current stock price is overvalued, and the stockholder recommendation
would be to sell.
Credit Risk Analysis
Altman Z-scores
2002
2003
2004
2005
2006
2.517
2.283
2.762
2.748
2.327
One method used by financial institutions to analyze credit risk of different
companies is the Altman Z-score. The Altman Z-score is a model that was
originally used to try and predict bankruptcy for companies. The model uses
different ratios from the Balance sheet and the Income Statement and assigns
different weights to each of them to come up with a number. The formula for
the Altman Z-score = 1.2(Working Capital/Total Assets) + 1.4(Retained
106
Earnings/Total Assets) + 3.3(EBIT/Total Assets) + .6(Market Value of
Equity/Book Value of Liabilities) + 1(Sales/Total Assets). This number
theoretically represents how risky that company is for potential investors. A
score below 1.81 is said to predict bankruptcy, and a score between 1.81 and
2.67 is what is called the “grey area”. Scores above 2.67 are said to be a low
risk firm.
The Altman Z-score for Sara Lee at the end of 2006 was 2.33, which lies
in the “grey area”. For the past 5 years, Sara Lee has only come out of this
range twice and not by very much. Going by this particular model, Sara Lee has
historically been a fairly risky firm for investors. One thing that stands out
looking at their ratios is the consistency of working capital being low. With this
low Z-score, Sara Lee might have some trouble getting access to borrowing in
the future. Another thing worth pointing out is the fact that Sara Lee has one of
the lowest scores after 2006 in 5 years. This doesn’t show investors that they
are doing things to decrease their risk, even though their score isn’t low enough
to alarm investors of a potential bankruptcy.
Analyst Recommendation
After careful examination of Sara Lee, its competitors, and the industry
that Sara Lee operates in, we have acquired a vast knowledge of the multi-billion
dollar corporation. Sara Lee is in the highly competitive packaged and processed
food industry, where price is a major competitive edge for the firms involved.
Sara Lee does a good job competing in this industry. Sara Lee has a
recognizable name associated with high-quality products. The company
definitely has a future and its managers appear to be leading the corporation in
the right direction.
107
Despite all of Sara Lee’s good qualities and characteristics the company’s
share price is overvalued. Every valuation technique we ran on the company,
except one, showed the firm to be overvalued. The one model that did show
Sara Lee to be undervalued was the discounted free cash flows. This model is
usually unreliable, and we do not put much value in its estimates.
The current market price for Sara Lee is $16.92. We feel the proper value
of the firm is best shown by the residual income model. This model gives the
value of $9.44 at a -30% growth rate and a cost of equity of 8.49%. Given this
information, we conclude that Sara Lee is overvalued and should be sold.
108
Appendix
109
BALANCE SHEET
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
298
1004
655
533
2231
1476
1608
1744
1886
2030
2113
2198
2284
2377
2472
Assets:
Cash and equivalents
11.9% to 14%
Accounts receivable
1768
1787
1848
1677
1750
1476
1535
1597
1662
1727
1797
1869
1943
2022
2102
11.9%
Inventories
2509
2652
2728
2151
2153
1490
1478
1466
1454
1440
1499
1559
1620
1686
1753
12.1% to 10%
341
359
380
410
301
7
110
125
1172
339
4923
5912
5736
5943
6774
4570
4754
4945
5146
5347
5564
5787
6015
6260
6509
118
Other current assets
Assets of discont operations
Total current assets
Other noncurrent assets
36.9%
192
281
143
117
4
453
281
53
91
176
195
148
130
135
127
132
137
142
148
154
160
167
173
180
Buildings and improvements
1744
1895
2030
1712
1795
1552
1615
1680
1748
1816
1890
1966
2043
2126
2211
Machinery and equipment
4299
4872
5045
4367
4531
3929
4088
4252
4425
4598
4784
4976
5172
5382
5597
320
289
382
204
258
236
246
255
266
276
287
299
311
323
336
Accumulated depreciation
3384
3939
4269
3577
3777
3251
3382
3517
3660
3803
3958
4116
4279
4453
4631
Property, net
3155
3312
3236
2836
2942
2573
2677
2784
2897
3010
3133
3258
3387
3524
3665
21.3%
Trademarks and intangibles,
2106
2058
1977
1395
1185
Goodwill
3314
3331
3354
3018
3052
0
149
152
938
360
13694
15496
14879
14300
14522
12368
12868
13382
13926
14471
15059
15662
16279
16941
17618
2.2%
asume 6.8%
ROA
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Deferred tax asset
Land
Construction in progress
Assets of discont. operations
Total Assets
Liabilities and Equity
Notes payable
468
140
84
239
1784
435
445
454
463
470
477
483
487
490
491
Accounts payable
1359
1314
1293
1115
1226
1058
1082
1105
1126
1144
1161
1175
1185
1192
1194
Payroll and benefits
1147
1193
1150
929
996
421
439
531
431
475
Taxes other than payroll
102
111
119
87
79
Income taxes payable
122
22
247
142
253
1047
900
829
774
790
Advertising and promotion
Other
Current maturities LT debt
734
1004
1070
380
368
Liabilities of discont operations
0
46
87
916
306
298
305
311
317
322
327
331
334
336
336
Total Current Liabilities
5400
5169
5410
5013
6277
4646
4752
4850
4945
5024
5100
5161
5204
5235
5243
Long-term debt
4357
5157
4171
4112
3807
11272
Pension obligation
Other liabilities
220
1178
870
766
436
1325
1496
1362
1410
1417
68
Liabilities of discont operations
0
18
7
206
Minority interest in subsidiaries
632
356
74
61
68
10746
13413
11894
11568
12073
9652
9851
10053
10249
10429
10614
10796
10950
11126
2948
2083
2985
2732
2449
2716
3016
3229
3678
4042
4445
4866
5330
5815
6346
13694
15496
14879
14300
14522
12368
12868
13382
13926
14471
15059
15662
16279
16941
17618
Total Liabilities
Total Common Equity
Total Liabilities and Equity
dec liab 17%
inc equity 17%
110
Common Size Balance Sheet
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
14.0%
Assets:
Cash and equivalents
2.2%
6.5%
4.4%
3.7%
15.4%
11.9%
12.5%
13.0%
13.5%
14.0%
14.0%
14.0%
14.0%
14.0%
Accounts receivable
12.9%
11.5%
12.4%
11.7%
12.1%
11.9%
11.9%
11.9%
11.9%
11.9%
11.9%
11.9%
11.9%
11.9%
11.9%
Inventories
18.3%
17.1%
18.3%
15.0%
14.8%
12.1%
11.5%
11.0%
10.4%
10.0%
10.0%
10.0%
10.0%
10.0%
10.0%
2.1%
36.9%
36.9%
36.9%
36.9%
36.9%
36.9%
36.9%
36.9%
36.9%
36.9%
1.0%
1.0%
1.0%
1.0%
1.0%
1.0%
1.0%
1.0%
1.0%
1.0%
Other current assets
2.5%
2.3%
2.6%
2.9%
Assets of discont operations
0.1%
0.7%
0.8%
8.2%
2.3%
Total current assets
36.0%
38.2%
38.6%
41.6%
46.6%
Other noncurrent assets
1.4%
1.8%
1.0%
0.8%
0.8%
Deferred tax asset
0.0%
2.9%
1.9%
0.4%
0.6%
Land
1.3%
1.3%
1.0%
0.9%
0.9%
Buildings and improvements
12.7%
12.2%
13.6%
12.0%
12.4%
12.6%
12.6%
12.6%
12.6%
12.6%
12.6%
12.6%
12.6%
12.6%
12.6%
Machinery and equipment
31.4%
31.4%
33.9%
30.5%
31.2%
31.8%
31.8%
31.8%
31.8%
31.8%
31.8%
31.8%
31.8%
31.8%
31.8%
Construction in progress
2.3%
1.9%
2.6%
1.4%
1.8%
1.9%
1.9%
1.9%
1.9%
1.9%
1.9%
1.9%
1.9%
1.9%
1.9%
Accumulated depreciation
24.7%
25.4%
28.7%
25.0%
26.0%
26.3%
26.3%
26.3%
26.3%
26.3%
26.3%
26.3%
26.3%
26.3%
26.3%
Property, net
23.0%
21.4%
21.7%
19.8%
20.3%
20.8%
20.8%
20.8%
20.8%
20.8%
20.8%
20.8%
20.8%
20.8%
20.8%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
Trademarks and intangibles,
15.4%
13.3%
13.3%
9.8%
8.2%
11.1%
Goodwill
24.2%
21.5%
22.5%
21.1%
21.0%
21.5%
Assets of discont. operations
0.0%
1.0%
1.0%
6.6%
2.5%
2.8%
Total Assets
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
Liabilities and Stockholders Equity
Notes payable
3.4%
0.9%
0.6%
1.7%
12.3%
3.5%
3.5%
3.4%
3.3%
3.3%
3.2%
3.1%
3.0%
2.9%
2.8%
Accounts payable
9.9%
8.5%
8.7%
7.8%
8.4%
8.6%
8.4%
8.3%
8.1%
7.9%
7.7%
7.5%
7.3%
7.0%
6.8%
Payroll and benefits
8.4%
7.7%
7.7%
6.5%
6.9%
Advertising and promotion
3.1%
2.8%
3.6%
3.0%
3.3%
Taxes other than payroll
0.7%
0.7%
0.8%
0.6%
0.5%
Income taxes payable
0.9%
0.1%
1.7%
1.0%
1.7%
5.4%
37.6%
36.9%
36.2%
35.5%
34.7%
33.9%
32.9%
32.0%
30.9%
29.8%
78.0%
76.6%
75.1%
73.6%
72.1%
70.5%
68.9%
67.3%
65.7%
64.0%
Other
7.6%
5.8%
5.6%
5.4%
Current maturities LT debt
5.4%
6.5%
7.2%
2.7%
2.5%
Liabilities of discont operations
0.0%
0.3%
0.6%
6.4%
2.1%
Total Current Liabilities
39.4%
33.4%
36.4%
35.1%
43.2%
Long-term debt
31.8%
33.3%
28.0%
28.8%
26.2%
3.0%
Pension obligation
1.6%
7.6%
5.8%
5.4%
Other liabilities
9.7%
9.7%
9.2%
9.9%
9.8%
Liabilities of discont operations
0.0%
0.1%
0.0%
1.4%
0.5%
Minority interest in subsidiaries
4.6%
2.3%
0.5%
0.4%
0.5%
Total Liabilities
78.5%
86.6%
79.9%
80.9%
83.1%
Total Common Equity
21.5%
13.4%
20.1%
19.1%
16.9%
22.0%
23.4%
24.1%
26.4%
27.9%
29.5%
31.1%
32.7%
34.3%
36.0%
Total Liabilities and Equity
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
111
STAEMENT OF CASH FLOWS
Net Income / Starting Line
less: contingent sale proceeds
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
1010
1187
1272
719
555
841
875
910
947
984
1024
1065
1107
1152
1198
0
0
-119
-117
-114
Depreciation & Depletion
471
525
561
570
541
Amortization of Intangible Assets
111
136
173
181
160
Impairment
0
0
0
350
587
net gain on business dispositions
0
-16
14
-69
-589
112
Deferred Income
21
5
166
186
0
42
149
60
57
Dec(Inc) In Receivables
93
94
-44
-199
-14
274
-59
-62
-65
-65
-70
-72
-74
-79
-80
Dec(Inc) In Inventories
Dec(Inc) In Other
Assets/Liabilities
304
-23
-45
8
108
663
12
12
12
14
-59
-60
-61
-66
-67
7
-17
44
-9
-65
Inc(Dec) In act payable
0
-126
45
0
-10
168
-24
-22
-22
-18
-17
-14
-10
-7
-2
1978
other
Inc(Dec) In Other Accruals
27
0
-174
-330
-96
1735
1824
2042
1350
1232
89
1600
1659
1694
1783
1711
1774
1839
1907
669
746
-530
-538
-625
251
-68
-70
-74
-74
-80
-82
-84
-90
-92
Net Assets From Acquisitions
Disposal Of business
investments
1930
-10
0
-2
-78
369
-104
-107
-113
-113
-122
-125
-128
-138
-141
136
0
137
86
868
602
-159
-164
-173
-173
-187
-192
-196
-210
-215
CFFI
2475
-674
-184
-233
365
1222
-331
-340
-360
-360
-389
-399
-409
-438
-447
FCF
4210
1150
1858
1117
1597
1311
1269
1319
1334
1423
1322
1375
1430
1469
1531
0
98
139
161
27
CFFO
Capital Expenditures
Proceeds From Sale Stock
Com/Pfd Purchased
138
-555
-350
-396
-561
1362
1773
-995
339
1033
37
503
1
1288
-467
124
-359
-19
178
1528
0
0
0
0
33
Cash Dividends Paid - Total
484
-497
470
-535
-464
1215
605
CFFF
-714
2231
Long Term Borrowings
Reduction In Long Term Debt
Inc(Dec) In Short Term
Borrowings
Other Sources - Financing
-8
112
Net Income / Starting Line
less: contingent sale
proceeds
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
Depreciation & Depletion
Amortization of Intangible
Assets
Impairment
net gain on business
dispositions
Deferred Income
other
Dec(Inc) In Receivables
9.2%
7.9%
-3.5%
-27.7%
-2.5%
32.6%
-6.7%
-6.8%
-6.9%
-6.6%
-6.8%
-6.8%
-6.7%
-6.9%
-6.7%
Dec(Inc) In Inventories
Dec(Inc) In Other
Assets/Liabilities
30.1%
-1.9%
-3.5%
1.1%
19.5%
78.8%
1.4%
1.3%
1.3%
1.4%
-5.8%
-5.6%
-5.5%
-5.7%
-5.6%
Inc(Dec) In act payable
0.0%
-10.6%
3.5%
0.0%
-1.8%
20.0%
-2.8%
-2.5%
-2.3%
-1.8%
-1.7%
-1.3%
-0.9%
-0.6%
-0.2%
171.8%
153.7%
160.5%
187.8%
222.0%
10.6%
182.9%
182.3%
178.9%
181.2%
167.1%
166.6%
166.1%
165.5%
165.1%
Inc(Dec) In Other Accruals
CFFO
Capital Expenditures
Net Assets From Acquisitions
Disposal Of business
investments
CFFI
FCF
Proceeds From Sale Stock
Com/Pfd Purchased
Long Term Borrowings
Reduction In Long Term Debt
Inc(Dec) In Short Term
Borrowings
Other Sources - Financing
Cash Dividends Paid - Total
CFFF
113
INCOME STATEMENT
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
14519
14919
15892
16029
15944
11806
12278
12769
13280
13811
14364
14938
15536
16157
16804
COGS
9001
9249
9684
10024
10023
7333
7626
7931
8249
8579
8922
9279
9650
10036
10437
62.1% of sales
GROSS INCOME
5518
5670
6208
6005
5921
4473
4652
4838
5032
5233
5442
5660
5886
6122
6367
37.9% of sales
SG&A
4245
4212
4811
4663
4843
3188
3315
3448
3586
3729
3878
4033
4195
4362
4537
27% of sales
1242
1458
1485
1369
911
1273
1324
1376
1432
1489
1548
1610
1675
1742
1811
177
340
270
288
308
214
222
231
240
250
260
270
281
292
304
10.8% of sales
2.1% of total
debt
80
80
80
90
80
62
64
67
69
72
75
78
81
84
88
1022
1023
1295
1180
683
1122
1165
1212
1261
1311
1363
1419
1475
1534
1595
9.5% of sales
126
(47)
244
99
273
392
408
424
441
456
477
496
516
537
558
35% tax rate
NET REVENUES
OPERATING
INCOME
INTEREST
EXPENSE
INTEREST INCOME
INCOME PRETAXES
INCOME TAXES
INCOME CONT OPS
NET INCOME
4% growth
rate
4.1% of A/R
896
1070
1051
1081
410
730
757
788
820
855
886
923
959
997
1037
6.2% of sales
1010
1174
1272
719
555
841
875
910
946
984
1024
1065
1107
1151
1198
7.1% of sales
COMMON SIZED INCOME STATEMENT
NET REVENUES
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
COGS
62.0%
62.0%
60.9%
62.5%
62.9%
62.1%
62.1%
62.1%
62.1%
62.1%
62.1%
62.1%
62.1%
62.1%
62.1%
GROSS INCOME
38.0%
38.0%
39.1%
37.5%
37.1%
37.9%
37.9%
37.9%
37.9%
37.9%
37.9%
37.9%
37.9%
37.9%
37.9%
SG&A
OPERATING
INCOME
29.2%
28.2%
30.3%
29.1%
30.4%
27.0%
27.0%
27.0%
27.0%
27.0%
27.0%
27.0%
27.0%
27.0%
27.0%
8.6%
9.8%
9.3%
8.5%
5.7%
10.8%
10.8%
10.8%
10.8%
10.8%
10.8%
10.8%
10.8%
10.8%
10.8%
INTEREST EXPENSE
1.2%
2.3%
1.7%
1.8%
1.9%
1.8%
1.8%
1.8%
1.8%
1.8%
1.8%
1.8%
1.8%
1.8%
1.8%
INTEREST INCOME
0.6%
0.5%
0.5%
0.6%
0.5%
0.5%
0.5%
0.5%
0.5%
0.5%
0.5%
0.5%
0.5%
0.5%
0.5%
INCOME PRE-TAXES
7.0%
6.9%
8.1%
7.4%
4.3%
9.5%
9.5%
9.5%
9.5%
9.5%
9.5%
9.5%
9.5%
9.5%
9.5%
INCOME TAXES
0.9%
-0.3%
1.5%
0.6%
1.7%
3.3%
3.3%
3.3%
3.3%
3.3%
3.3%
3.3%
3.3%
3.3%
3.3%
INCOME CONT OPS
6.2%
7.2%
6.6%
6.7%
2.6%
6.2%
6.2%
6.2%
6.2%
6.2%
6.2%
6.2%
6.2%
6.2%
6.2%
NET INCOME
7.0%
7.9%
8.0%
4.5%
3.5%
7.1%
7.1%
7.1%
7.1%
7.1%
7.1%
7.1%
7.1%
7.1%
7.1%
114
Discounted Dividends Model
0
Earnings
3
4
5
6
7
8
9
10
P
2017
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
$555
$841
$875
$910
$946
$984
$1,024
$1,065
$1,107
$1,151
$1,198
$575
$575
$597
$597
$620
$620
$643
$643
$666
$666
PV Factor
0.922
0.850
0.783
0.722
0.665
0.613
0.565
0.521
0.480
0.443
PV Dividends
$522
$475
$449
$408
$385
$350
$330
$300
$283
$257
$4,025
PV Terminal Value
$4,548
Estimated Value
$8,573
Estimated Value per share (7/31/06)
$11.19
Estimated Value per share (4/1/07)
$11.24
Actual Price
$16.92
Cost of Equity (Ke)
2
Dividends
Sum of PV Dividends
Growth
1
$666
0.02
0.08488
Sensitivity Analysis
g
Ke
0.00
0.01
0.02
0.03
0.04
0.06
$14.06
$15.68
$18.12
$22.17
$30.30
0.07
$12.00
$13.05
$14.54
$16.75
$20.35
0.085
$9.84
$10.45
$11.24
$12.33
$13.91
0.09
$9.27
$9.78
$10.43
$11.32
$12.54
0.10
$8.31
$8.68
$9.15
$9.75
$10.56
Undervalued
Overvalued
115
Abnormal Earnings Growth
Model
Earnings
Dividends
Div Invested at
8.488%
Cum-Dividend
Earnings
Normal Earnings
AEG
PV Factor
PV of AEG
Core Earnings
Total PV of AEG
PV of Terminal Value
Estimation
Estimation per share (7/31/06)
Estimation per share (4/1/07)
Actual Price
Growth
Cost of Equity (Ke)
0
2006
$555
1
2007
$841
$575
2
2008
$875
$575
3
2009
$910
$597
4
2010
$946
$597
5
2011
$984
$620
6
2012
$1,024
$620
7
2013
$1,065
$643
8
2014
$1,107
$643
9
2015
$1,151
$666
10
2016
$1,198
$666
$49
$49
$51
$51
$53
$53
$55
$55
$57
$57
$924
$71
$852
0.855
$729
$961
$74
$886
0.731
$648
$997
$77
$919
0.624
$574
$1,037
$80
$956
0.534
$510
$1,077
$84
$993
0.456
$453
$1,120
$87
$1,033
0.390
$403
$1,162
$90
$1,071
0.333
$357
$1,208
$94
$1,114
0.285
$317
$1,255
$98
$1,157
0.243
$282
(0.10)
(0.20)
g
(0.30)
(0.40)
(0.50)
$8.82
$8.61
$8.33
$8.24
$8.07
$7.92
$7.80
$7.63
$7.57
$7.46
$7.51
$7.42
$7.29
$7.25
$7.16
$7.28
$7.21
$7.09
$7.06
$6.98
$7.13
$7.07
$6.96
$6.92
$6.86
P
2017
$1,157
$3,006
$555
$4,272
$732
$5,558
$7.26
$7.29
$16.92
(0.30)
0.08488
Sensitivity
Analysis
Ke
0.06
0.07
0.085
0.09
0.1
Undervalued
Overvalued
116
Residual Income Model
Beginning BVE
Earnings
Dividends
Ending BVE
Normal Income
Residual Income
PV Factor
PV of Residual Income
BVE
Total PV of RI
$2,449
$4,185
PV Terminal Value
Estimated Value
$336
$6,970
Estimated Value per share
(7/31/06)
Estimated Value per share
(4/1/07)
Actual Price
Growth
Cost of Equity (Ke)
0
2006
$2,449
$555
1
2007
$2,716
$841
$575
$2,716
$231
$610
0.922
$563
2
2008
$3,016
$875
$575
$3,017
$256
$619
0.850
$526
3
2009
$3,229
$910
$597
$3,329
$274
$636
0.783
$498
4
2010
$3,678
$946
$597
$3,578
$312
$634
0.722
$458
5
2011
$4,042
$984
$620
$4,042
$343
$641
0.665
$426
6
2012
$4,445
$1,024
$920
$4,446
$377
$647
0.613
$397
7
2013
$4,866
$1,065
$643
$4,867
$413
$652
0.565
$369
8
2014
$5,330
$1,107
$643
$5,330
$452
$655
0.521
$341
P
2017
$292
g
(0.10)
(0.20)
(0.30)
(0.40)
(0.50)
$9.44
0.06
$12.00
$11.47
$11.24
$11.11
$11.02
$16.92
0.07
$11.10
$10.66
$10.46
$10.34
$10.27
0.08488
$9.92
$9.59
$9.44
$9.34
$9.28
0.09
$9.56
$9.26
$9.11
$9.02
$8.96
0.1
$8.90
$8.65
$8.52
$8.44
$8.39
(0.30)
10
2016
$6,346
$1,198
$666
$6,347
$539
$659
0.443
$292
Sensitivity
Analysis
$9.10
0.08488
9
2015
$5,815
$1,151
$666
$5,815
$494
$657
0.480
$316
Ke
Undervalued
Overvalued
117
Free Cash Flow Model
Cash from Operations
Cash Provided by
Investing
Free Cash Flow
PV Factor
PV Free Cash Flow
Sum of PV Free Cash
Flow
$10,027
PV Terminal Value
$21,910
Book Value Liabilities
$12,073
Estimation Value
$19,865
Estimation Value per
share (7/31/06)
1
2
3
4
5
6
7
8
9
10
P
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
$1,232
$89
$1,600
$1,659
$1,694
$1,783
$1,711
$1,774
$1,839
$1,907
$1,978
$1,222
($331)
($340)
($360)
($360)
($389)
($399)
($409)
($438)
($447)
$1,311
$1,269
$1,319
$1,334
$1,423
$1,322
$1,375
$1,430
$1,469
$1,531
0.943
0.889
0.838
0.79
0.745
0.702
0.662
0.624
0.588
0.555
$1,236
$1,128
$1,105
$1,054
$1,060
$928
$910
$892
$864
$849
$26.02
Actual Price
$16.92
Growth Rate
$1,608
Sensitivity
Analysis
g
$25.93
Estimation Value per
share (4/1/07)
WACC
0
2006
0
0.01
0.02
0.03
0.04
0.04
$34.28
$46.11
$69.79
$140.84
N/A
0.05
$23.88
$30.33
$41.09
$62.63
$127.23
0.0607
$16.57
$20.36
$26.02
$35.37
$53.75
0.02
0.07
$12.05
$14.60
$18.16
$23.52
$32.45
0.0607
0.08
$8.37
$10.11
$12.45
$15.70
$20.58
WACC
Undervalued
Overvalued
118
Long Run Residual Income Model
g
g
ROE
0.06
12.18
13.97
16.66
21.14
30.11
0.07
10.44
11.65
13.33
15.86
20.07
Ke
0.08488
8.61
9.33
10.27
11.56
13.42
0.09
8.12
8.73
9.52
10.57
12.04
0.10
7.31
7.76
8.33
9.06
10.04
0.10
3.79
3.87
3.97
4.11
4.30
0.15
5.69
6.02
6.45
7.04
7.89
ROE
0.227
8.61
9.33
10.27
11.56
13.42
0.25
9.48
10.32
11.41
12.91
15.07
0.30
11.38
12.47
13.90
15.84
18.65
0.06
6.44
10.47
16.66
18.52
22.54
0.07
5.15
8.37
13.33
14.81
18.03
Ke
0.08488
3.97
6.45
10.27
11.41
13.90
0.09
3.68
5.98
9.52
10.58
12.88
0.10
3.22
5.23
8.33
9.26
11.27
Actual Price
$16.92
0
0.01
0.02
0.03
0.04
*ROE=22.7%
0
0.01
0.02
0.03
0.04
*Ke=8.488%
0.1
0.15
0.227
0.25
0.3
*g=2%
Undervalued
Overvalued
Undervalued
Overvalued
Undervalued
Overvalued
119
Forward P/E
PPS
SLE
GIS
KFT
$16.02
$51.79
$35.70
Price to Sales
EPS
$0.72
$3.05
$1.86
P/E
$22.25
$16.98
$19.19
IND.
AVG
SLE
PPS
$13.02
$18.09
Trailing P/E
$19.65
$49.68
$28.17
EPS
$0.91
$3.34
$1.72
P/E
$21.59
$14.87
$16.38
IND.
AVG
SLE
PPS
$14.22
$15.63
$16.02
$51.79
$35.70
P/S
$20.81
$32.51
$19.81
$0.77
$1.59
$1.80
IND.
AVG
SLE
PPS
$35.38
$1.70
PPS
$16.02
$51.79
$35.70
PPS
SLE
GIS
KFT
$16.02
$51.79
$35.70
DPS
D/P
$0.79
$1.34
$0.96
$0.49
$0.26
$0.27
IND.
AVG
SLE
PPS
$2.93
$0.27
Price Earning
Growth
Price to Book
SLE
GIS
KFT
SLE
GIS
KFT
SPS
Dividend to Price
PPS
SLE
GIS
KFT
PPS
BPS
$3.22
$16.12
$17.45
P/B
$4.98
$3.21
$2.05
IND.
AVG
SLE
PPS
$8.47
$2.63
PPS
SLE
GIS
KFT
$16.02
$51.79
$35.70
EPS
$0.72
$3.05
$1.86
G
PEG
4.00%
7.50%
5.00%
$23.18
$18.36
$20.20
IND.
AVG
SLE
PPS
$13.32
$19.28
120
2002
IGR
2003
Sara Lee
3.84%
4.37%
Kraft
4.27%
4.29%
4.05%
1.11%
2002
SGR
2003
Sara Lee
4.47%
5.41%
Kraft
4.12%
2.95%
3.90%
0.83%
General Mills
General Mills
2004
2005
3.75% 1.78%
0.94% 2.53%
0.40% 0.59%
2004
2005
2006
0.76%
2.69%
2.90%
2003
0.96%
4.65% 2.08%
0.90% 2.41%
2.54%
0.08% 0.49%
2.66%
121
Cost of Equity Estimations:
Months
72
60
48
36
24
Months
72
60
48
36
24
Months
72
60
48
36
24
10 Year
(Rf =
5.92%)
Beta
0.3247
0.6521
0.4693
0.5983
0.6479
R^2
0.0485
0.1831
0.0581
0.1078
0.0986
Ke
0.0777
0.0964
0.086
0.0934
0.0962
5 Year
(Rf =
4.71%)
Beta
0.3225
0.6496
0.4677
0.5973
0.6444
R^2
0.0481
0.1823
0.0575
0.1082
0.0987
Ke
0.0617
0.0766
0.0683
0.0742
0.0764
3 Month
(Rf =
5.16%)
Beta
0.3236
0.655
0.4749
0.6136
0.6382
R^2
0.0485
0.1846
0.0604
0.1142
0.0947
Ke
0.068
0.0849
0.0757
0.0828
0.084
Months
72
60
48
36
24
Months
72
60
48
36
24
7 Year
(Rf =
4.71%)
Beta
0.3217
0.648
0.4659
0.5929
0.6456
R^2
0.0478
0.1814
0.0566
0.1065
0.0991
Ke
0.0616
0.0763
0.0681
0.0738
0.0762
1 Year
(Rf =
5.05%)
Beta
0.3244
0.6545
0.4738
0.6126
0.6399
R^2
0.0488
0.1845
0.0602
0.1141
0.0958
Ke
0.0665
0.0829
0.0739
0.0808
0.0822
122
Cost of Debt (WACC)
% of Total Liabilites
Interest Rate
Computed Interest Rate
Current Liabilities
Notes Payable
1784
14.78%
5.16%
0.76%
Accounts Payable
1226
10.15%
5.16%
0.52%
Employee Benefits
996
8.25%
5.16%
0.43%
Other
2271
18.81%
5.16%
0.97%
Total Current Debt
6277
51.99%
Long-Term Debt
3807
31.53%
6.03%
1.90%
Other
1989
16.47%
5.74%
0.95%
Total Long-Term Debt
5796
48.01%
Long-Term Liabilities
Total Liabilities
Tax Rate
12073
100.00%
35%
WACD
5.53%
WACE
8.49%
MVD
12073
MVE
12359
MVA
24432
WACC
6.07%
Break Down of Long-Term
Debt
6.125% Notes
11.35% Mex. Pesos
6.13%
759
1.22%
11.35%
34
0.10%
5.6-6.95% medium notes
6.28%
252
0.42%
2.75% Notes
2.75%
300
0.22%
7.05-7.40% Notes
7.23%
75
0.14%
6.5% Notes
6.50%
150
0.26%
0.05%
7.26-7.71% Notes
7.49%
25
6.25% Notes
6.25%
1110
1.82%
3.875% Notes
3.88%
500
0.51%
10% zero coupon notes
10.00%
9
0.02%
10-14.25% zero coupon notes
12.13%
39
0.12%
6.125% Notes
6.13%
500
0.80%
1.95% notes
1.95%
0
0.00%
4.625% euro notes
4.63%
0
0.00%
1.55% jap. Yen
1.55%
0
0.00%
euro - euribor+.10%
4.13%
316
0.34%
total long term liabilities
Cost of Debt (long term)
3807
6.03%
123
Forecasted Financial Ratios
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Liquidity Analysis
Current Ratio
0.98
1.00
1.02
1.04
1.06
1.09
1.12
1.16
1.20
1.24
Quick Asset Ratio
0.32
0.34
0.36
0.38
0.40
0.41
0.43
0.44
0.45
0.47
Accounts Receivable Turnover
Days Supply of Receivables
Inventory Turnover
8.00
8.00
8.00
7.99
8.00
7.99
7.99
8.00
7.99
7.99
45.63
45.64
45.64
45.67
45.63
45.66
45.66
45.64
45.67
45.66
4.92
5.16
5.41
5.67
5.96
5.95
5.95
5.96
5.95
5.95
Days Supply of Inventory
74.18
70.75
67.44
64.33
61.27
61.31
61.31
61.28
61.32
61.31
Working Capital Turnover
-155.46
4515.40
135.43
66.22
42.78
30.94
23.85
19.15
15.78
13.27
Gross Profit Margin
37.89%
37.89%
37.89%
37.89%
37.89%
37.89%
37.89%
37.89%
37.89%
37.89%
Operating Expense Ratio
27.00%
27.00%
27.00%
27.00%
27.00%
27.00%
27.00%
27.00%
27.00%
27.00%
7.13%
7.13%
7.13%
7.13%
7.13%
7.13%
7.13%
7.13%
7.13%
7.13%
Profitability Analysis
Net Profit Margin
Asset Turnover
0.95
0.95
0.95
0.95
0.95
0.95
0.95
0.95
0.95
0.95
Return on Assets
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
6.80%
Return on Equity
30.98%
29.01%
28.18%
25.73%
24.35%
23.03%
21.88%
20.77%
19.80%
18.87%
3.55
3.27
3.11
2.79
2.58
2.39
2.22
2.05
1.91
1.78
Capital Structure Analysis
Debt to Equity Ratio
Times Interset Earned
5.96
5.96
5.96
5.96
5.96
5.96
5.96
5.96
5.96
5.96
Debt Service Margin
0.20
3.60
3.65
3.66
3.79
3.58
3.67
3.77
3.89
4.03
124
Altman Z-score
2002
2003
2004
2005
2006
-477
743
326
930
497
Retained Earnings
3,168
3,787
4,437
4,361
3,855
EBIT
1,119
1,283
1,485
1,378
911
Working Capital
Sales
14,519 14,919 15,892 16,029 15,944
Total Assets
Market Value of
Equity
13,694 15,469 14,879 14,300 14,522
16,202 14,402 18,258 15,504 12,271
Book Value of Equity
10,746 13,413 11,894 11,568 12,073
Altman Z-scores
2002
2003
2004
2005
2006
2.517
2.283
2.762
2.748
2.327
125
Multiple R
R Square
Adjusted R Square
Standard Error
Observations
0.248
0.062
72 mo.
Regression Statistics
0.049
0.050
73.000
df
1.000
SS
0.012
MS
0.012
Residual
Total
71.000
72.000
Coefficients
0.181
0.193
Standard Error
0.003
Intercept
0.002
0.006
mkt prem.
mkt prem.
0.325
0.325
0.150
0.150
Regression
10 Year Regressions
Regression Statistics
F
4.672
Significance F
0.034
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
0.256
0.799
0.010
0.013
0.010
0.013
2.161
2.161
0.034
0.034
0.025
0.025
0.624
0.624
0.025
0.025
0.624
0.624
Upper 95.0%
60 mo.
Regression Statistics
48 mo.
Multiple R
0.443
Multiple R
0.279
R Square
Adjusted R Square
0.197
0.183
R Square
Adjusted R Square
0.078
0.058
Standard Error
0.047
Standard Error
0.039
Observations
61.000
df
1.000
Observations
49.000
df
1.000
Regression
SS
0.032
MS
0.032
0.002
F
14.444
Significance F
0.000
Regression
Residual
59.000
0.131
Total
60.000
0.163
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Intercept
0.000
0.006
0.002
0.998
0.012
0.012
mkt prem.
0.652
0.172
3.801
0.000
0.309
0.995
Regression Statistics
SS
0.006
MS
0.006
0.002
F
3.960
Significance F
0.052
Residual
47.000
0.071
Total
48.000
0.077
Upper 95.0%
Coefficients
Standard Error
t Stat
Pvalue
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
0.012
0.012
Intercept
0.003
0.006
0.524
0.603
0.015
0.009
0.015
0.009
0.309
0.995
mkt prem.
0.469
0.236
1.990
0.052
0.005
0.944
0.005
0.944
36 mo.
Regression Statistics
24 mo.
Multiple R
0.364
Multiple R
0.369
R Square
0.133
R Square
0.136
Adjusted R Square
0.108
Adjusted R Square
0.099
Standard Error
0.031
Standard Error
0.032
Observations
37.000
df
Observations
SS
MS
F
Significance F
25.000
df
SS
MS
F
Significance F
Regression
1.000
0.005
0.005
5.349
0.027
Regression
1.000
0.004
0.004
3.626
0.069
Residual
35.000
0.034
0.001
Residual
23.000
0.023
0.001
Total
36.000
0.039
Total
24.000
0.027
Intercept
Coefficients
0.004
Standard Error
0.005
t Stat
0.844
P-value
0.404
Lower 95%
0.015
Upper 95%
0.006
Lower 95.0%
0.015
Upper 95.0%
0.006
Intercept
Coefficients
0.012
Standard Error
0.006
t Stat
1.864
Pvalue
0.075
Lower 95%
0.025
Upper 95%
0.001
Lower 95.0%
0.025
Upper 95.0%
0.001
mkt prem.
0.598
0.259
2.313
0.027
0.073
1.123
0.073
1.123
0.648
0.340
1.904
0.069
0.056
1.352
0.056
1.352
mkt prem.
126
Multiple R
0.247
72 mo.
R Square
0.061
Regression Statistics
7 Year Regression
Adj. R Square
0.048
Standard Error
0.050
Observations
73.000
df
SS
MS
F
Significance F
Regression
1.000
0.012
0.012
4.615
0.035
0.003
Residual
71.000
0.181
Total
72.000
0.193
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Intercept
0.001
0.006
0.230
0.819
0.010
0.013
0.010
0.013
mkt prem.
0.322
0.150
2.148
0.035
0.023
0.620
0.023
0.620
Regression Statistics
60 mo.
Regression Statistics
Multiple R
48 mo.
Multiple R
0.442
R Square
0.195
R Square
0.076
Adj. R Square
0.181
Adj. R Square
0.057
Standard Error
0.047
Standard Error
0.039
Observations
61.000
Observations
49.000
df
SS
MS
F
Significance F
Regression
1.000
0.006
0.006
3.880
0.055
Residual
47.000
0.071
0.002
df
SS
MS
F
Significance F
Regression
1.000
0.032
0.032
14.294
0.000
Residual
59.000
0.131
0.002
Total
60.000
0.163
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Intercept
0.000
0.006
0.067
0.947
0.013
0.012
0.013
0.012
mkt prem.
0.648
0.171
3.781
0.000
0.305
0.991
0.305
0.991
Regression Statistics
0.276
Total
36 mo.
48.000
0.077
Coefficients
St. Error
t Stat
Pvalue
Lower 95%
Upper 95%
Lower 95.0%
Intercept
0.003
0.006
0.578
0.566
0.015
0.008
0.015
0.008
mkt prem.
0.466
0.237
1.970
0.055
0.010
0.942
0.010
0.942
Upper 95.0%
Regression Statistics
Multiple R
Upper 95.0%
24 mo.
Multiple R
0.362
0.370
R Square
0.131
R Square
0.137
Adj. R Square
0.106
Adj. R Square
0.099
Standard Error
0.031
Standard Error
0.032
Observations
37.000
Observations
25.000
df
SS
MS
F
Significance F
Regression
1.000
0.004
0.004
3.641
0.069
Residual
23.000
0.023
0.001
Total
24.000
0.027
Coefficients
St. Error
t Stat
Pvalue
df
SS
MS
F
Significance F
1.000
0.005
0.005
5.289
0.028
Residual
35.000
0.034
0.001
Total
36.000
0.039
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Lower 95%
Upper 95%
Lower 95.0%
Intercept
0.005
0.005
0.944
0.352
0.015
0.006
0.015
0.006
Intercept
0.013
0.006
1.949
0.064
0.026
0.001
0.026
0.001
mkt prem.
0.593
0.258
2.300
0.028
0.070
1.116
0.070
1.116
mkt prem.
0.645
0.338
1.908
0.069
0.054
1.345
0.054
1.345
Regression
127
Multiple R
0.248
72 mo.
R Square
0.061
Regression Statistics
5 Year Regressions
Adj. R Square
0.048
Standard Error
0.050
Observations
73.000
df
SS
MS
F
Significance F
Regression
1.000
0.012
0.012
4.640
0.035
0.003
Residual
71.000
0.181
Total
72.000
0.193
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Intercept
0.001
0.006
0.216
0.829
0.011
0.013
0.011
0.013
mkt prem.
0.323
0.150
2.154
0.035
0.024
0.621
0.024
0.621
Regression Statistics
Multiple R
0.443
R Square
0.196
R Square
0.077
Adj. R Square
0.182
Adj. R Square
0.057
Standard Error
0.047
Standard Error
0.039
Observations
61.000
df
Observations
SS
MS
F
Significance F
49.000
df
SS
MS
F
Significance F
Regression
1.000
0.032
0.032
14.373
0.000
Regression
1.000
0.006
0.006
3.926
0.053
Residual
59.000
0.131
0.002
Residual
47.000
0.071
0.002
Total
60.000
0.163
Total
48.000
0.077
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Coefficients
St. Error
t Stat
Pvalue
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Intercept
0.001
0.006
0.095
0.925
0.013
0.012
0.013
0.012
Intercept
0.003
0.006
0.596
0.554
0.015
0.008
0.015
0.008
mkt prem.
0.650
0.171
3.791
0.000
0.307
0.992
0.307
0.992
mkt prem.
0.468
0.236
1.981
0.053
0.007
0.943
0.007
0.943
62 mo.
Regression Statistics
Multiple R
R Square
Upper 95.0%
Regression Statistics
Multiple R
0.278
36 mo.
48 mo.
Regression Statistics
0.365
0.133
Multiple R
R Square
24 mo.
0.369
0.136
Adj. R Square
0.108
Adj. R Square
0.099
Standard Error
0.031
Standard Error
0.032
Observations
37.000
df
Observations
SS
MS
F
Significance F
25.000
df
SS
MS
F
Significance F
Regression
1.000
0.005
0.005
5.369
0.026
Regression
1.000
0.004
0.004
3.627
0.069
Residual
35.000
0.034
0.001
Residual
23.000
0.023
0.001
Total
36.000
0.039
Total
24.000
0.027
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Coefficients
St. Error
t Stat
Pvalue
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Intercept
0.005
0.005
0.963
0.342
0.015
0.005
0.015
0.005
Intercept
0.013
0.006
1.951
0.063
0.026
0.001
0.026
0.001
mkt prem.
0.597
0.258
2.317
0.026
0.074
1.121
0.074
1.121
mkt prem.
0.644
0.338
1.904
0.069
0.056
1.344
0.056
1.344
128
Multiple R
0.249
72 mo.
R Square
0.062
Regression Statistics
1 Year Regressions
Adj. R Square
0.049
Standard Error
0.050
Observations
73.000
df
SS
MS
F
Significance F
Regression
1.000
0.012
0.012
4.692
0.034
Residual
71.000
0.181
0.003
Total
72.000
0.193
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Intercept
0.001
0.006
0.169
0.866
0.011
0.013
0.011
0.013
mkt prem.
0.324
0.150
2.166
0.034
0.026
0.623
0.026
0.623
Regression Statistics
Upper 95.0%
60 mo.
Regression Statistics
Multiple R
48 mo.
Multiple R
0.445
R Square
0.198
R Square
0.080
Adj. R Square
0.185
Adj. R Square
0.060
Standard Error
0.047
Standard Error
0.039
Observations
Observations
Regression
61.000
df
1.000
SS
0.032
MS
0.032
Regression
49.000
df
1.000
SS
0.006
MS
0.006
Residual
59.000
0.131
0.002
Residual
47.000
0.071
0.002
Total
60.000
0.163
Total
48.000
0.077
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Coefficients
St. Error
Intercept
0.001
0.006
0.186
0.853
0.013
0.011
0.013
0.011
Intercept
0.004
mkt prem.
0.655
0.171
3.818
0.000
0.312
0.998
0.312
0.998
mkt prem.
0.474
Regression Statistics
F
14.580
Significance F
0.000
36 mo.
0.282
F
4.074
Significance F
0.049
t Stat
Pvalue
Lower 95%
Upper 95%
Lower 95.0%
0.006
0.655
0.516
0.016
0.008
0.016
0.008
0.235
2.018
0.049
0.002
0.946
0.002
0.946
Regression Statistics
24 mo.
Multiple R
0.372
R Square
0.139
R Square
0.133
Adj. R Square
0.114
Adj. R Square
0.096
Standard Error
0.031
Standard Error
0.032
Observations
37.000
df
Observations
SS
MS
F
Significance F
25.000
df
SS
MS
F
Significance F
1.000
0.005
0.005
5.636
0.023
Regression
1.000
0.004
0.004
3.543
0.072
0.001
Residual
23.000
0.023
0.001
Total
24.000
0.027
St. Error
0.006
t Stat
1.949
Pvalue
0.064
Lower 95%
0.026
Upper 95%
0.001
Lower 95.0%
0.026
Upper 95.0%
0.001
0.340
1.882
0.072
0.063
1.343
0.063
1.343
Regression
Multiple R
Upper 95.0%
0.365
Residual
35.000
0.034
Total
36.000
0.039
Intercept
Coefficients
0.005
St. Error
0.005
t Stat
1.021
P-value
0.314
Lower 95%
0.016
Upper 95%
0.005
Lower 95.0%
0.016
Upper 95.0%
0.005
Intercept
Coefficients
0.013
mkt prem.
0.613
0.258
2.374
0.023
0.089
1.136
0.089
1.136
mkt prem.
0.640
129
Multiple R
0.248
72 mo.
R Square
0.062
Regression Statistics
3 Month Regressions
Adj. R Square
0.049
Standard Error
0.050
Observations
73.000
df
SS
MS
F
Significance F
Regression
1.000
0.012
0.012
4.673
0.034
0.003
Residual
71.000
0.181
Total
72.000
0.193
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Intercept
0.001
0.006
0.157
0.875
0.011
0.013
0.011
0.013
mkt prem.
0.324
0.150
2.162
0.034
0.025
0.622
0.025
0.622
Regression Statistics
Upper 95.0%
60 mo.
Regression Statistics
Multiple R
48 mo.
Multiple R
0.445
0.283
R Square
0.198
R Square
0.080
Adj. R Square
0.185
Adj. R Square
0.060
Standard Error
0.047
Standard Error
0.039
Observations
61.000
df
Observations
SS
MS
F
Significance F
49.000
df
SS
MS
F
Significance F
Regression
1.000
0.032
0.032
14.583
0.000
Regression
1.000
0.006
0.006
4.086
0.049
Residual
59.000
0.131
0.002
Residual
47.000
0.071
0.002
Total
60.000
0.163
Total
48.000
0.077
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Intercept
0.001
0.006
0.213
0.832
0.013
0.011
0.013
0.011
Intercept
0.004
0.006
0.674
0.504
0.016
0.008
0.016
0.008
mkt prem.
0.655
0.172
3.819
0.000
0.312
0.998
0.312
0.998
mkt premium
0.475
0.235
2.021
0.049
0.002
0.948
0.002
0.948
F
3.511
Significance F
0.074
Regression Statistics
36 mo.
Regression Statistics
Multiple R
24 mo.
Multiple R
0.373
R Square
0.139
R Square
0.132
Adj. R Square
0.114
Adj. R Square
0.095
Standard Error
0.031
Standard Error
0.032
Observations
37.000
Observations
25.000
Regression
df
1.000
SS
0.005
MS
0.005
Regression
df
1.000
SS
0.004
MS
0.004
Residual
35.000
0.034
0.001
Residual
23.000
0.023
0.001
Total
36.000
0.039
Total
24.000
0.027
F
5.642
Significance F
0.023
Upper 95.0%
0.364
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Coefficients
St. Error
t Stat
P-value
Lower 95%
Upper 95%
Lower 95.0%
Upper 95.0%
Intercept
0.005
0.005
1.050
0.301
0.016
0.005
0.016
0.005
Intercept
0.013
0.006
1.960
0.062
0.026
0.001
0.026
0.001
mkt prem.
0.614
0.258
2.375
0.023
0.089
1.138
0.089
1.138
mkt prem.
0.638
0.341
1.874
0.074
0.066
1.343
0.066
1.343
130
Screening Ratio Analysis
Sara Lee
2002
2003
2004
2005
2006
Net Sales/Cash from sales
N/A
1.00
1.00
0.99
1.00
Net Sales/Net Accounts Receivable
8.21
8.35
8.60
9.56
9.11
Net Sales/Unearned Revenues
N/A
N/A
N/A
N/A
N/A
Net Sales/Warranty Liabilities
N/A
N/A
N/A
N/A
N/A
Net Sales/Inventory
5.79
5.63
5.83
7.45
7.41
Asset Turnover (Sales/Assets)
1.06
0.96
1.07
1.12
1.10
CFFO/Operating Income
1.72
1.55
1.61
1.88
2.22
CFFO/Net Operating Assets
0.55
0.55
0.63
0.48
0.42
2002
2003
2004
2005
2006
Net Sales/Cash from sales
N/A
1.00
1.00
1.00
1.00
Net Sales/Net Accounts Receivable
7.87
10.72 7.87
10.87 10.82
Net Sales/Unearned Revenues
N/A
N/A
N/A
N/A
N/A
Net Sales/Warranty Liabilities
N/A
N/A
N/A
N/A
N/A
Net Sales/Inventory
7.53
9.71
10.41 10.84 11.03
Asset Turnover (Sales/Assets)
0.48
0.58
0.60
0.62
0.64
CFFO/Operating Income
0.72
0.82
0.70
0.85
0.89
CFFO/Net Operating Assets
0.33
0.55
0.47
0.57
0.59
2002
2003
2004
2005
2006*
Net Sales/Cash from sales
N/A
1.01
1.01
1.00
1.01
Net Sales/Net Accounts Receivable
9.54
9.20
9.09
10.08 8.88
Net Sales/Unearned Revenues
N/A
N/A
N/A
N/A
N/A
Net Sales/Warranty Liabilities
N/A
N/A
N/A
N/A
N/A
Net Sales/Inventory
8.79
9.28
9.33
10.20 9.80
Asset Turnover (Sales/Assets)
0.52
0.52
0.54
0.59
0.62
CFFO/Operating Income
0.59
0.69
0.75
0.66
0.71
CFFO/Net Operating Assets
0.39
0.41
0.40
0.35
0.38
General Mills
Kraft
*The following charts illustrate and compare Sara Lee’s screening ratios to their major competitors.
131
References
1. Edgar Scan, www.edgarscan.com
2. Conagra Corporation, www.conagra.com
3. Kraft Corporation, www.kraft.com
4. Sara Lee Corporation, www.saralee.com
5. St. Louis Federal Reserve website
6. Yahoo Finance, www.yahoo.com/finance
7. CNBC, www.cnbc.com
8. General Mills Corporation, www.generalmills.com
9. Investopedia, www.investopedia.com
10. Morning Star, www.morningstar.com
11. Unilever Corporation, www.unilever.com
12. Kelloggs Corporation, www.kelloggs.com
13. Chicago Tribune, www.chicagotribune.com
14. Business Valuations and Analysis, Palepu Bernerd, Healy
15. Wall Street Journal www.wsj.com
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