Sysco Corporation (SYY, Financial), a Dividend Aristocrat, is among the top-two global food distributors in the country. The company markets and distributes a range of food related products primarily to the foodservice or food-away-from-home industry. The company’s third-quarter results failed to beat analysts’ expectations on the top- and bottom-line.
Third-quarter numbers
Sysco clocked net sales of $11.747 billion which was higher than the year-ago quarter by 4.2% on the back of 2.5% volume growth from acquisitions. Acquisitions contributed 0.6% growth to sales. However, 1.3% negative impact of currency movements more than wiped this gain off. The sales growth was not enough to surpass the consensus estimates.
Gross profit grew 3.1% year-over-year to $2.1 billion, and gross margin registered a decline of 17 basis points, or bps, to 17.52%. The decline was due to ongoing cost pressures. Also, adjusted operating expenses increased 4.5% year-over-year as a result of which adjusted operating income went down 2.7% year-over-year to $377 million.
Adjusted earnings grew 5.3% year-over-year and came in at $0.40 per share. Consensus estimate was pegged higher at $0.41 per share. Clearly, gross margin pressures stung earnings this quarter. Sysco exited the third-quarter with cash and cash equivalents were $5.09 billion and long-term debt of $7.28 billion.
Risk ahead
Sysco’s strategy of shopping for growth has panned out well until it got caught in long-drawn legal complications with respect to its proposed acquisition of US Foods. I am hopeful that divesting some additional parts of US Foods will help Sysco get past the FTC objections, and finally go through with the acquisition. However, what if the deal doesn’t go through? Few points to note:
- Sysco will have to pay $300 million to US Foods as terminating fee.
- In addition, the company will have to shell out $25 million to Performance Food Group, which is willing to buy part of the divested business of US Foods.
- Also, if the deal doesn’t go through or is terminated by October 8, then Sysco will bear additional $265 million in losses.
All in all, this could cost Sysco close to $1 billion, according to a report from Reuters.
Gross margin pressure
Sysco’s gross margin has been under pressure since last two fiscal years due a variety of reasons. In addition negative impact of currency translations is also a credible headwind for the company. The gross margin contraction has been on account of pricing pressures as a result of slow recovery rate in the food service market.
To mitigate these challenges, the company set out on a cost cutting roadmap initiated in 2013. Sysco has progressed well and has already exceeded its original target of $600 million, consisting of around $300 million in annual savings in both operating and product costs.
Shopping for growth
In addition, Sysco is also shopping for growth and the company recently completed the acquisition of Pacific Food Services in Mexico. Acquisitions do offer a lot of cost cutting opportunities in the long run, besides offering advantages of scale of operations.
During the recently reported quarter, acquisitions contributed to 0.6% year over year increase in sales. Case volume grew 0.3% during the quarter as a result of acquisitions.
Wrapping up
US Foods acquisition will be crucial for Sysco’s growth trajectory, going forward. The company has been demonstrating growth over the years but has been negatively impacted by currency translations and pricing pressures.
The stock is trading at a trailing P/E of 25.8 and forward P/E of 18.93 signifies expected growth in earnings, going forward. For the next five years, analysts have pegged growth at a CAGR of 6.6% versus a decline of 2.81% in the preceding five years. The stock is down around 6% year-to-date and this pullback is a good buying opportunity.
However, investors should take a note of the US Foods impending acquisition risks as I mentioned earlier.
