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UPS and Sysco Priced to Deliver

January 10, 2008 | About:
Mike Rubsam

Mike Rubsam

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There’s nothing like high oil prices and a shrinking economy to make most investors thoroughly uninterested in transportation and distribution companies as investments. Transports of all shapes and sizes have sold off, and some for good reason…business stinks.

Yet a couple of my favorite trannies are now selling at interesting prices, in my opinion. UPS ($66.7) and Sysco (SYY, $28.8) may fall further, but are priced at very low valuations given their track record of high returns on capital and growth.

While most people are familiar with UPS, Sysco is the type of company that very few people interact with directly. Their business is delivering food to restaurants (64% of sales), hospitals, schools, and hotels. Clearly, the restaurant business is suffering for a number of reasons, but Sysco has the benefits of market leadership and cost advantage, to go along with a very conservative balance sheet. These strengths should work to Sysco’s advantage in a business downturn, as food distribution has high fixed costs and is very fragmented. The company has raised dividends for 37 straight years, in a number of economic environments, and has historically been very successful at passing inflation through to its customers.

A business risk facing Sysco is the state of independent restaurants. Independents are the majority of Sysco’s customers, and are faced with dwindling customer counts but higher operational costs. It is likely that some restaurants will shut their doors, and that others will order less food in this environment, but Sysco should also see new customers who switch from higher-cost suppliers. This is a good example of a case where recessions are good for strong businesses in the long run, as it is much easier to become stronger when competitors are floundering. Sysco estimates it has 15% market share of the $225 billion “meals eaten away from home” category; each share point is worth over $2 billion or 6% growth to Sysco’s $35 billion revenue base. In my opinion it is certainly feasible that Sysco gains some share in the next few years, either from organic growth or by acquiring distressed rivals, adding long-term value. A 1-2% market share gain would likely more than offset any recessionary weakness in the business.

At first blush a distributor with a 17 multiple may not seem interesting, but Sysco’s free cash flow growth history (FCF has grown from $300 M/year to $800 M/year this decade) indicates a cheap and safe stock.

UPS’ current valuation is very similar to SYY’s and the business faces some of the same issues. I am generally skeptical of massive stock buybacks, but UPS’ recently announced $10 billion buyback financed by debt makes sense to me given low interest rates and UPS’ steady income history, along with a discounted stock.

Since its IPO almost 10 years ago, UPS stock has done nothing will sales and profits have climbed steadily. That UPS has been able to maintain returns given a sluggish economy and high oil prices speaks to the resilience of its business, yet the stock market has not given the company any credit. The company at around 16X earnings trades at a discount to the market, yet has significantly better earnings quality, stability, and visibility than the average company. I think the stock is significantly undervalued, even if we are in a recession and over 75% of UPS’ business is domestic. Much like Sysco, UPS will likely be presented with interesting, discounted acquisition possibilities in this environment.

If stocks are cheap, safe, understandable, and boring, I feel pretty good being long, even in a period of weak economic performance, and recently bought shares in both companies.

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Mike Rubsam is President of Liberty Steward Capital (http://libertystewardcapital.com)

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Mike Rubsam
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