However, I have ulterior motives that go beyond this individual stock and deal with broader, and I believe, more important universal investing principles. At its core, I will use this article on Sysco to illustrate important differences between speculation and investment. Once again, I will offer a quote from chapter 1 of legendary investor Ben Graham’s highly regarded book, "The Intelligent Investor:"
“Investment versus Speculation, What do we mean by “investor”? Throughout this book the term will be used in contradistinction to 'speculator.' As far back as 1934, in our textbook Security Analysis, we attempted a precise formulation of the difference between the two, as follows: 'An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return.' Operations not meeting these requirements are speculative.”
This is important, because what prompted Ben Graham to devote his first chapter to the important distinction between speculators versus investors parallels the prevailing attitudes of many people today that consider common stocks speculations or gambles. Later in his first chapter, Ben Graham gave us this:
“Compare this with the attitude of the public toward common stocks in 1948, when over 90% of those queried expressed themselves as opposed to the purchase of common stocks. About half gave as their reason 'not safe, a gamble…'”
In addition to the importance of thorough analysis that defines a person as an investor, I believe that another important distinction implies a long-term holding. The true investor does not expend the time and resources necessary to conduct thorough analysis with the intent of only holding an investment for a very short period of time. In other words, true investors exercise what I call 'intelligent patience' based on the confidence garnered by thorough analysis.
For example, Sysco was trading at $29.34 a year ago when I wrote the first article, and was paying approximately $.98 a share in dividends. Today, Sysco trades at approximately $28 a share, but currently offers a dividend of $1.08 per share. As an investor who purchased this stock to own for the long run, the current price does not disturb me because I had not planned to sell for at least three to five years (a minimum of a full business cycle). On the other hand, I am pleased that my dividend income has increased.
Unfortunately, at least in my opinion, we seem to live in an age driven by the desire for instant gratification that is inadvertently turning wannabe investors into speculators (gamblers). Consequently, there is an inherent lack of patience with people willing and ready to react to every little wiggle in stock price that Mr. Market offers up. To those “speculators” the lack of a rise in Sysco’s stock price troubles them; while in contrast, it bothers me not. I’ve admired this company for many years, but Mr. Market valued it well beyond my comfort range. Therefore, the rest of this article will deal with why I’m gratified to have the opportunity to now hold this blue-chip, dividend-paying stalwart in my portfolios.
Sysco - A Dividend Champion on Sale
For starters, I would like to state that I believe that Sysco is one of the highest quality dividend paying common stocks available. Standard & Poor’s currently awards them an “Extra Strong A1 short-term issuer credit rating” and an A+ long-term issuer credit rating. Value Line rates Sysco’s financial strength A++. Therefore, I am confident that this Dividend Champion/Aristocrat with 42 consecutive years of dividend increases offers a safe and well-covered dividend and an above-average and growing current yield.
The following 20-year performance (more than 19 years) clearly illustrates Sysco’s excellent record of continuous dividend increases and above-average capital appreciation. One of the criticisms that I have heard regarding this blue-chip is how their dividend growth rate has been rather anemic lately. But I do not consider the last two years' dividend increases of 5% and 7% especially low. Most utility stocks with similar yields that are popular have lower growth than that. However, there are also a couple of extremely important points that I believe these critics are additionally failing to consider.
First of all, Sysco has recently been investing heavily into a transformation project that portends to increase future profitability, perhaps even dramatically, as I will discuss later. Second, you will note that the company has significantly increased its payout ratio which I believe illustrates a commitment to shareholders during the recent, and I believe temporary, slowdown in profitability. I believe that Sysco’s generous attitude towards shareholders will result in a reacceleration of dividend growth when the initial expense of their transformation project subsides.
Short-Term Profitability Has Slowed
Since 1993, Sysco has generated average earnings per share growth in excess of 11% per annum. As the performance table above illustrates, the company’s dividend growth rate has far exceeded earnings growth. However, as the following earnings and price correlated F.A.S.T. Graphs™ illustrates, Sysco’s average earnings per share growth rate has fallen to 6.6% per annum since calendar year 2007, one year preceding the great recession.
The pessimist could see this slowdown in earnings growth as a negative; however, I the eternal optimist, offer a different perspective. To me, it’s a testament to the quality of this company and its management team that its profitability has remained positive and strong during and through these recent challenging economic times. Growth may have slowed, but this blue-chip industry-leading company has remained profitable through it all, and dividends have continued to grow, albeit it at a slower rate.
When you compare Sysco’s earnings record during and through our recent recessionary period with that of the average company, we get a perspective of the quality of this business. The following earnings- and price-correlated graph on the S&P 500 clearly shows that the average company struggled a lot more than Sysco did. Furthermore, I would like to interject here, and expand more on later, that Sysco’s operating record includes a significant increase in capital investment to improve future profitability, that most of their competitors were incapable of doing.
Sysco – A Legacy of Premium Valuation
Sysco is a company that the market has historically placed a quality premium valuation on its share price. Consequently, although I always admired the company and its prudent management team, overvaluation precluded me from investing, until the great recession of 2008 came along. Finally, after admiring this company from afar for so many years, it finally was priced at a valuation that made sound economic sense. Nevertheless, I find it befuddling that many want to avoid this stock now, when for the first time in decades, it can be purchased at a sound and reasonable valuation. Oh, the peculiar illogic of Wall Street.
Even at today’s historically low valuation, long-term shareholders of Sysco have seen their investments significantly outperform the average as benchmarked against the S&P 500. I want to repeat, and emphasize, that this is even considering that Sysco’s shares have gone from being mostly overvalued during this time to currently fairly valued.
Forecasting Sysco’s Future Growth Rates
The following estimated earnings and return calculator is based in part on the five year consensus earnings growth rate estimates from 10 analysts reporting to Standard & Poor’s Capital IQ. However, this fiscal year’s and next fiscal year’s actual earnings per share estimates are also provided. There is a lot of cynicism regarding the accuracy, or even the reliability of trusting analyst estimates to predict the future growth of the business. Personally, based on many decades of experience, I believe the skepticism is way overblown.
Many will try to point to the fact that analyst estimates are rarely accurate. But my contention is that it would be naïve to expect them to be perfectly precise. On the other hand, I believe it is logical to expect them to be within a reasonable range of probabilities. In other words, if an analyst estimates a company to earn a dollar per share, but the company only earns $.99, is that really a miss? To my way of thinking, it is not a miss, because it would be well within a realistic range. Consequently, I believe there is greater error in how we tabulate the accuracy of analyst estimates, than there is within the actual analyst error.
Furthermore, I believe consideration should be given to the reality that most of the analysts’ forecast comes directly from the company’s management. In my experience at least, no one can forecast the prospects of a company’s future better than the people that are directly in charge of creating it. Moreover, it behooves the management team more to provide conservative guidance that they can exceed, than it does to set unreachable targets.
Moreover, prospective investors should understand most analysts are basing their estimates on the same information that is available to all the other analysts. Consequently, I would argue that consensus earnings estimates represent a conservative and sound starting point from which to evaluate the future prospects of the business.
Therefore, from the following graph we can expect a modest -2% drop in earnings growth for this fiscal year ending June 30, followed by a modest 1% increase for next fiscal year before the 6% to 8% five-year growth rate kicks in. In other words, for reasons which I will discuss later, Sysco’s short-term earnings should be flat before beginning to grow again at the estimated 6% to 8% rate (rounded to 7% on the graph). However, I would also add that in my opinion, I believe the shorter-term estimates may be reasonably close, but I believe the longer-term growth rate is conservatively understated.
Thesis for Growth
The following excerpts from Sysco’s third quarter earnings conference call on May 7, 2012 by CEO Bill Delaney summarizes Sysco’s quarter and provides insight into the company’s ambitious transformation project.
“William J. DeLaney
Thank you, Neil, and good morning, everyone. This morning, Sysco reported sales of $10.5 billion for the third quarter, a 7.6% increase. Case volume grew 3% including acquisitions, and we believe we continue to gain market share in the industry, which has shown little to no real growth for a number of quarters.
Net earnings for the quarter were $260 million and reported EPS was $0.44. Adjusted EPS was $0.49 and excludes several items including gross business transformation costs. On this basis, adjusted EPS grew 2% for the quarter. We believe this adjusted amount is more representative of the performance of our underlying business. The modest improvement in market conditions we experienced in the latter portion of the second quarter continued through the third quarter, due in part to an unseasonably mild winter in much of the northern part of the geography we serve. Our volume growth for the quarter was solid across nearly all of our business segments as we improved our customer retention, increased our overall account penetration and attracted many new customers to Sysco.
Turning to an update on our multiyear business transformation initiative and as we discussed on our second quarter earnings call, we implemented a new technology platform at our second pilot facility back in Oklahoma back in January. While we saw significant improvement in the system's performance compared to our early experience in our first pilot in Arkansas, we did identify certain processes that require additional assessment and enhancement. We are addressing those opportunities now and are targeting a third rollout early in fiscal 2013. Successfully implementing this technology platform is a critical component to our transformation of Sysco……
Effectively driving our transformational change in a company such as Sysco, which has enjoyed a great deal of success over the past 40 years, can be challenging at times. However, in our case, we absolutely need to embrace such change if we are to continue to perform at a high level in a world that is much different than just a few years ago. Notwithstanding the predictable bumps that come with this type of journey, we remain highly focused on positioning Sysco to be a top-performing company for years to come.”
The following clip from Sysco’s website provides further detail on Sysco’s commitment to accelerating their growth as their general industry mends. The point I’m trying to illustrate here, is that Sysco’s management team is, in my opinion, taking the necessary steps to ensure that the company remains strong, competitive and poised for future growth. Moreover, the expense of these initiatives (which incidentally have exceeded original estimates) is as much a contributor to the company’s short-term weakness and earnings slowdown than is the overall state of their industry.
2012 Investors Day May 17, 2012
The following slides are taken directly from Sysco’s recent presentation that has provided the foundation for the analyst estimates discussed above. This full slide presentation can be found by going onto the company’s website and clicking the "Investors" tab and then "Events and Presentations." By doing this, you can review of the same information that the analysts were given and from which they base their earnings estimates. For the sake of time and space, I offer the slides as reasons and evidence of long-term growth opportunity for this blue-chip dividend paying industry leader.
I believe the sides are self-explanatory and clearly illustrate the opportunity without a need for additional rhetoric on my part. However, to summarize what I believe this presentation shows is a company that has a small piece of a very large pie that is uniquely positioned due to its size, strength and scope to continue growing by capturing market share regardless of the growth prospects of the industry itself.
Summary and Conclusions
What I’ve attempted to demonstrate regarding Sysco Corp. specifically is a picture of an extremely high quality powerful franchise that is positioning itself for long-term future growth. Currently, the company controls about 17.5% of the $225 billion North American food service distribution market. Since this industry is currently experiencing stress, it seems only logical that Sysco is best positioned among its peers to survive and prosper. On the other hand, many of its smaller local and regional competitors may not.
For the past 40 years Sysco has been a successful participant in the industry’s consolidation completing more than 150 acquisitions. Since the great recession (2008), Sysco has averaged about four acquisitions per year. But, now that their transformation program is well under way, that is rapidly changing. Sysco has already completed eight acquisitions in fiscal 2012 and anticipates closing on more than 10 before the end of June. I do not believe that their 4% to 6% underlying business growth guidance fully reflects acquisitions. This year’s acquisitions alone should add more than 1% sales growth.
As I stated in my opening remarks, I wrote this article with ulterior motives in mind. Based on what I see over the next couple of years, I do not expect to see a great deal of growth or perhaps even price appreciation with Sysco’s share price. On the other hand, based on how the market has normally capitalized their shares I don’t rule the prospects out. But most importantly, I do not believe there is a lot of downside from investing in this high-quality blue-chip either. The current yield is better than you can get on long-term Treasury bonds, and I do expect Sysco to grow dividends in excess of earnings.
On the other hand, over the longer run I believe the prospects for growth will accelerate and perhaps even exceed the 6% to 8% current expectation. Over the longer run, I expect the trend towards eating out will continue, especially considering that more and more families are depending on two income earners. Therefore, there is no stay-at-home parent or spouse that is willing or even has the time to prepare the family meals.
But before I digress too much, the moral of the story is that this is an investment that I believe will attract the prudent investor with a long-term time horizon. Furthermore, I believe the risk is low, the yield is high and the potential for future above-average growth is high. It may not happen overnight, but I believe it’s inevitable that it will eventually happen. At least I feel safe in saying that there is no company in the food service distribution industry that is better positioned than this blue-chip Dividend Champion/Aristocrat. However, it takes an investor mentality to appreciate and exploit the opportunities that this investment offers. Speculators may want to look elsewhere.
Disclosure: Long SYY at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment adviser as to the suitability of such investments for his specific situation.