Sara Lee: No Piece of Cake

CEO McMillan has cut costs, but investors want growth

After watching Sara Lee (SLE ) Corp. struggle through years of lackluster results, Wall Street hailed C. Steven McMillan when he landed the CEO job in July, 2000. The company veteran promised to reshape the $18 billion hodgepodge -- spanning its namesake baked goods, Jimmy Dean sausages, Hanes underwear, and the Wonderbra -- into a focused business that would start growing again in three years.

Well, McMillan's deadline is almost up, and guess what? He doesn't appear to be much closer to redefining the Chicago-based conglomerate. In attempting to rationalize Sara Lee's three major product groups of food (52% of sales), apparel (37%), and household goods (11%), he sold noncore assets such as luxury leather-goods maker Coach (COH ) Inc. but spent big to add food operations such as breadmaker Earthgrains Co., driving up debt and giving McMillan a bunch of new brands to manage. Aggressive cost-cutting helped pump up profits in fiscal 2001. But since then, earnings have retreated -- from $2.3 billion in '01 to $1 billion in the 12 months ended last June -- while revenues remain flat. In the quarter ended Mar. 29, Sara Lee's sales adjusted for currency gains fell 2%. Profits rose 4.7%, to $269 million.

More recently, Sara Lee has found itself on the edges of an accounting scandal involving rebate payments to grocers. Federal investigators are looking into such payments at Dutch grocer Royal Ahold (AHO ) U.S. Foodservice (AHO ) Div. There is no evidence so far that Sara Lee made any improper payments. McMillan says three of his salespeople on their own gave inflated rebate figures to U.S. Foodservice's executives and its auditor, Deloitte & Touche. Sara Lee says the Securities & Exchange Commission has contacted it only to check on the accuracy of U.S. Foodservice's numbers. McMillan insists Sara Lee's bookkeeping reflected the deals accurately: "We've gotten ourselves totally comfortable with how we handle these rebates." Questions are one reason the stock is off 24% this year, to $17.62.

McMillan's plan: Take six months to decide which businesses are worth hanging on to, squeezing more out of the strong brands and cutting costs. "We need to go back and prioritize even more aggressively where we are going to spend our money," he told shareholders on Apr. 24. But some investors wonder if McMillan should get more time. "The board needs to ask if the company is in the right businesses, or even whether this is the right management to pull it through," says Kevin R. McCloskey, portfolio manager at Federated Investors Inc., who recently sold a third of his 3 million Sara Lee shares.

The sheer size of Sara Lee's portfolio, with 200 brands, creates a daunting management challenge. "What is frustrating is that Sara Lee, unlike a Procter & Gamble (PG ), hasn't quite figured out how to focus on key brands and drive growth," says Robert G. Millen, co-portfolio manager at Jensen Investment Management Inc. in Portland, Ore. That puts it in a tough spot with big grocery chains. "Wal-Mart stocks at best the two top brands, and if Sara Lee's isn't one of those, it's out," says Burt Flickinger III, managing partner at consultant Strategic Resource Group.

Investors applaud McMillan's cost-cutting -- he will save $100 million this fiscal year, in part by closing five bakeries. And he got full value for the units he unloaded. Coach was spun off in 2000 through a stock offering that raised $967 million. PYA/Monarch (AHO ) Inc., a food-service business, was sold the same year to Ahold for $1.6 billion.

But half of Sara Lee's remaining businesses are still underperforming, admits McMillan, and they stay only because of their cash flow. L'eggs pantyhose has seen years of double-digit volume declines. Chock full o' Nuts coffee has fallen victim to onslaughts from the likes of P&G's Folgers. Meanwhile, investors are still looking for a payoff from the 2001 acquisition of Earthgrains, the No. 2 U.S. baker. That deal boosted Sara Lee's debt by almost $2 billion, to $5 billion. Its $2.8 billion price tag now seems outrageous -- industry leader Interstate Bakeries (IBC ) Corp. has $1 billion more in sales and a market value of $450 million.

McMillan blames much of Sara Lee's performance on the weak economy. But the company also hasn't been as successful as its rivals in creating blockbuster new products. Kraft expanded its Lunchables line of boxed meals into a $1 billion franchise. Sara Lee's Jimmy Dean frozen croissants are selling well but still aren't a national brand. Sara Lee breads, introduced in October, are expected to rack up sales of $100 million this fiscal year -- $70 million more than expected but hardly enough to spark a turnaround.

The best way to unlock value may be to dismantle Sara Lee, creating three separate companies. That would be a massive undertaking, admits analyst Romitha Mally of Goldman, Sachs & Co., but she thinks it would give management a clearer picture of what works. Counters McMillan: "It's not like I haven't considered a breakup analysis of Sara Lee." But among other things, such a move could cost Sara Lee its low 18% tax rate, based on apparel operations in places like South America.

So McMillan will get on with the job of sorting the wheat from the chaff. But to shareholders, it's getting to be a tired refrain. And after years of poor returns, they're ready for McMillan -- or somebody else -- to sing a different tune.

By Pallavi Gogoi in Chicago

    Before it's here, it's on the Bloomberg Terminal.