Costs put Sara Lee CEO in tight bind

DOWNERS GROVE - Sara Lee Corp. said it will post a write-down of nearly $1 billion in the fiscal fourth quarter - the latest sign that rising commodity costs are hampering Chief Executive Officer Brenda Barnes's turnaround plan.

The company said that high wheat costs and the weak economy hurt its North American food-service bakery and Spanish bakery divisions, hampering their ability to support the goodwill placed on them when Sara Lee acquired the Earthgrains bread company in 2001. As a result, Sara Lee has to record a noncash charge of $865 million to $975 million in the quarter ended June 28.

The company also said it has received a nonbinding offer for parts of its North American food-service business but didn't identify the bidder. Sara Lee will report fourth-quarter results Aug. 7.

The challenges facing Sara Lee's bakery businesses underscore the problems Barnes has faced since becoming chief executive in February 2005. At that time, she predicted that she would turn Sara Lee, a sagging hodgepodge of disparate businesses, into a tightly focused consumer-products company churning out 12 percent margins.

Now, Barnes finds herself in a tough spot, with few options to bolster shareholder value. Margins are nowhere near 12 percent, and the stock is down 35 percent since she became CEO, a decline that also reflects divestitures and the spinoff of an apparel business.

Investors are growing increasingly restive, but although the company continues to face breakup speculation, that option would be difficult to execute. Selling its profitable European household and body-care business - the division that would probably attract the most interest - would bring a huge tax hit. And selling that unit would leave Sara Lee with a strong overseas coffee business but also with bakery and meat businesses that have been struggling with high commodity costs and strong competition.

Activist hedge-fund ValueAct Capital Management LP has a 6 percent stake in Sara Lee, the largest after Barclays Global Investors' holdings, but so far it has stayed quiet. In fact, no one is calling for a management shake-up yet, largely because analysts and investors seem to agree that no matter who's in charge, Sara Lee will be a tough ship to turn.

"I think they're doing the best they can given the hand they've been dealt," says Stifel Nicolaus analyst Christopher Growe. "They're facing significant (commodity) cost inflation, and they have categories that just don't respond well to price increases."

Barnes inherited a conglomerate with dozens of brands that made everything from cheesecake to underwear to shoe polish. The former head of North American operations for PepsiCo Inc., who famously left that post in 1997 to raise her children, quickly embarked on a major housecleaning at Sara Lee, shedding businesses that accounted for 40 percent of revenue and consolidating operations.

But Sara Lee still lacks a clear focus. It sells Douwe Egberts coffee, Sanex deodorant and Hit insect repellent overseas, and Sara Lee bread, Hillshire Farm deli meat and Jimmy Dean sausage in the U.S.

Barnes has tried to place Sara Lee meat and bread products next to each other in grocery stores and push more products to the stores' perimeters, which generate more traffic than the center aisles. Sara Lee hot-dog buns can now be found not just in bread aisles but also in meat sections, near the company's Ball Park hot dogs.

But the moves don't always work. During a recent trip to a grocery store in suburban Chicago, Barnes began her tour in the produce department, where she looked to see if any rivals were selling new prepackaged salads. Sara Lee last year introduced Hillshire Farm Salad Entrees, kits that contained meat and many salad-making ingredients - from salad dressing to croutons, bacon bits and cheese - except lettuce. But the salad kits didn't sell well, and Sara Lee discontinued them earlier this year. "We took the Hillshire Farm brand too far away from its core product, which is meat," Ms. Barnes says.

Although Sara Lee has been able to pass along higher costs - it has raised its bread prices four times since April 2007 - cereal makers like General Mills Inc. and Kellogg Co. have been able to weather the high commodity costs without hurting volume and margins as much, partly because their brands are stronger.

Sara Lee has some of the lowest profit margins in the food business, at 7.7 percent in its third quarter, compared with the 17.5 percent General Mills reported in a similar period and the 15.5 percent at Heinz.

When Barnes first joined Sara Lee, she discovered that each of the company's business units did its own purchasing and did little, if any, hedging, so she created a centralized procurement department. She also moved the meat people from Cincinnati and the bread people from St. Louis to a new corporate headquarters in Downers Grove.

Barnes has said that now that the structural transformation is largely complete, she's open to making acquisitions, though she won't say what she'd like to buy. One likely target, according to analysts, would be Interstate Bakeries Corp., maker of Wonder Bread.

The company has had some successes with its existing lineup. Sara Lee Soft & Smooth bread has helped make Sara Lee the No. 1 fresh bakery brand in the U.S. Jimmy Dean breakfast skillets, bowls and sandwiches have revamped the staid sausage brand, and women's foot-care products have pumped new life into the century-old Kiwi shoe-polish brand.

New products helped boost sales 10 percent in the third quarter to $13.2 billion, and Barnes says the revenue growth hasn't been getting enough attention amid the struggling margins.

"I feel great about the progress," she says. "I don't feel great about the stock price."

Neither do shareholders. "The average investor, I think, has lost patience," says Greg Spivy, a partner at ValueAct Capital. "We are longer-term focused and willing to wait for the results of this dramatic overhaul, but Brenda and her team need to start showing more progress - and soon."

Barnes says she's moving as quickly as she can but regrets having set that 12-percent margin goal up front.

"It was stupid," she says. "I did not anticipate the disruption that happened, with investors saying, 'You'll never pull it off.' From that point on we were crawling out of a hole."