Published November 13th, 2016 by Bob Ciura
Sysco Corporation (SYY) started out as a small company with a simple mission: to assist foodservice companies in providing customers with quality meals consumed away from home.
The company went public in 1970. That year, it had sales of $115 million. Last year, Sysco’s sales exceeded $50 billion.
Today, Sysco approximately 425,000 customers. It operates in 194 locations throughout the U.S., Bahamas, Canada, and Ireland. The company has more than 50,000 employees.
Sysco is a Dividend Aristocrat, an exclusive group of companies in the S&P 500 that have increased dividends for at least 25 years in a row. You can see the entire list of Dividend Aristocrats by clicking here.
Sysco has increased its dividend 47 times in the past 46 years.
Sysco is in the food distribution industry. It provides food products to a wide variety of customers. A breakdown of Sysco’s customer base is as follows:
- Restaurants (63% of sales)
- Healthcare (9% of sales)
- Education/Government (8% of sales)
- Travel/Leisure/Retail (8% of sales)
- Other (12% of sales)
The ‘other’ category includes bakeries, churches, civic and fraternal organizations, vending distributors, and international exports.
The foodservice industry in the U.S. is enormous.
Source: Jefferies 2016 Consumer Conference, page 6
The downside of operating in such a huge industry is that there is not much room for growth. On the other hand, it provides Sysco with its main competitive advantage, which is economies of scale.
In order to generate growth, Sysco is aggressively pursuing acquisitions.
Sysco’s earnings-per-share growth over the past several years has disappointed. In fact, the company’s earnings-per-share were lower last year than five years ago.
Source: 2016 Annual Report, page 23
Sysco continues to grow, both organically and through acquisition. Its most important acquisition this year was a $3.1 billion takeover of U.K.-based Brakes Group.
Source: Jefferies 2016 Consumer Conference, page 8
The Brakes Group is a leading European foodservice distributor. It supplies fresh, refrigerated, and frozen food and non-food products and supplies.
Brakes has more than 50,000 customers. Its customers are large businesses and small businesses, including pubs, restaurants, hotels, hospitals, and caterers.
Acquiring Brakes brings a number of potential benefits. First, it provides Sysco with immediate international growth. Previously, Sysco generated nearly all of its revenue in the U.S.
The Brakes acquisition is a significant growth catalyst for Sysco. It provides Sysco with considerable growth in Europe. This is important for Sysco, since the U.S. foodservice industry is a highly saturated and competitive market.
Sysco states in its annual report that there are more than 16,000 direct competitors in the U.S. alone.
Now, it has a dominant market position in the U.K., France, and Sweden, in addition to a significant presence in Ireland, Belgium, Spain, and Luxembourg.
In addition, Sysco should realize high synergies from the acquisition. Brakes has a similar advantage of scale opportunities.
Source: Jefferies 2016 Consumer Conference, page 12
As you can see, Sysco management’s growth plan consists largely of margin expansion. The company aims to increase operating income by $500 million and a 15% return on invested capital by 2018.
Competitive Advantages & Recession Performance
Sysco’s biggest competitive advantage is scale. It operates 194 distribution facilities, which is a huge network that keeps competition at bay. There are significantly high barriers to entry to the foodservice industry.
It would be extremely capital-intensive to enter the foodservice distribution business and effectively compete with industry giants like Sysco.
Another competitive advantage that Sysco has built for itself over its many decades of existence is successful relationships with its customers. Sysco has developed a reputation in the industry for high quality, which keeps customer retention rates high.
The benefit of the food distribution industry is stability. As the saying goes, “people gotta eat.” That means Sysco has the ability to remain consistently profitable. Its profits held up well even during the Great Recession of 2007-2009:
- 2007 Earnings-per-share of $1.60
- 2008 Earnings-per-share of $1.81 (13% growth)
- 2009 Earnings-per-share of $1.77 (2% decline)
- 2010 Earnings-per-share of $1.99 (12% growth)
Even during periods of recession, foodservice remains a stable industry. This allowed Sysco to grow earnings-per-share in 2008, which not many companies can say for themselves.
This steady profitability gave Sysco the ability to continue increasing its dividend in 2007-2009, which was arguably the worst recession since the Great Depression.
Valuation & Expected Total Return
Sysco’s reliability comes with a price. The stock is valued at an adjusted price-to-earnings ratio of around 23.5. The stock is cheaper than the S&P 500, which trades for a price-to-earnings ratio of 25.
On the other hand, since 2000 Sysco stock traded for an average price-to-earnings ratio of 17. From that perspective, the stock is a bit overvalued based on its historical average valuation.
The reason for Sysco’s relative overvaluation is likely due to investors’ demand for yield. In a low interest rate climate, income investors have rushed into high-quality dividend stocks to provide income. Fixed income securities like bonds yield less than stocks in many cases. This has pushed Sysco’s yield down (and valuation up).
Going forward, Sysco’s total shareholder returns will be comprised of the following factors:
- 2%-3% organic revenue growth
- 1%-2% revenue growth through acquisitions
- 2% margin expansion
- 1% share repurchases
- 2.3% dividend
Therefore, investors can reasonably expect to earn 8.3%-10.3% total returns, less any contraction in the price-to-earnings multiple.
Sysco is a highly reliable dividend stock. It generates steady profitability from year to year, which fuels its dividend payments and future dividend growth.
Going forward, investors can expect Sysco to continue increasing its dividend. Earnings-per-share should continue growing from acquisitions and cost cuts.
That being said, income investors should not expect to receive high rates of dividend growth. Over the past five years, Sysco has increased its dividend by 3% compounded annually.
Sysco’s dividend growth over the past five years has barely beaten inflation. The company does make up for slower growth with its safety. The company has an average rank using The 8 Rules of Dividend Investing; Sysco is a hold at current prices.