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Nathan Parsh
Nathan Parsh
Articles (161) 

Buy Sysco for the Long Term

The company had an ugly end to its fiscal year, but it has plenty of reasons for optimism

September 23, 2020 | About:

As we all undoubtedly aware, the pandemic has greatly impacted the food service industry. Sysco Corporation (NYSE:SYY), a giant in the food service industry, has felt the brunt of the closing of restaurants worldwide. Shares are down 26% year-to-date, but have gained nearly 11% over the last month.

As the lowering of restrictions on restaurants in many states and countries have taken place, Sysco has likely seen the bottom in its business (though it may be a while yet before many people are willing to risk exposure to the virus by eating out often). The company also pays a solid dividend.

This article will examine the company's most recent quarter, dividend growth history and valuation in order to determine whether long-term investors should consider purchasing the stock today,

Recent earnings results

Sysco reported its fourth quarter results for fiscal 2020 on Aug. 11. Revenue for the quarter decreased 43% year-over-year to $8.9 billion, which was $1.25 billion lower than expected. Adjusted earnings per share swung from a profit of $1.10 a year ago to a loss of $0.29, which was 2 cents higher than analysts predicted.

The top and bottom-line declines were an acceleration from the third quarter, where revenue decreased 6.6% and EPS fell 43%. For the year, sales fell 12% to $52.9 billion while adjusted EPS was down 43% to $2.01.

U.S. Foodservice Operations, which accounted for more than two-thirds of total revenues in the quarter, was down 43% to $6.1 billion. Total case volumes were lower by 41.5% with an organic decline of 41.9%. Almost all of this decline was related to restaurants being closed for part or all of the quarter.

One plus was that food cost inflation was relatively flat as inflation in the price of beef was offset by deflation in poultry and frozen food categories.

International Foodservice Operations suffered a 53.4% decline to $1.4 billion. Excluding currency, sales were 51.9%. The company did see solid results in the UK, Ireland and France, which was the top performer in Europe, as these countries had mostly reopened at the start of the quarter.

Gross profit for the company fell 47.4% to $1.6 billion and gross margins contracted 159 basis points to 17.7%, which was above consensus estimates of 17.2%. Adjusted operating expenses decreased 26% to $1.6 billion as Sysco did well to manage its costs during the quarter.

Despite a difficult quarter, Sysco's balance sheet is solid. The company ended the fiscal year with $12.3 billion in assets, including $6.1 billion in cash and cash equivalents and $3 billion in inventory. The company also has $2 billion in available liquidity should it need it. Sysco's current liabilities are $6.7 billion. Sysco has $15.1 billion in total debt, with $1.7 billion set to mature within the next year.

Sysco is expected to produce EPS of $1.77 for fiscal 2021, according to Yahoo Finance, as Covid-19 related impact will likely continue over in to at least the early part of the next fiscal year.

Surely some of Sysco's clients will not be able to survive the current environment even as restrictions on restaurants have begun to ease in the U.S and around the world, but the company will still likely retain its leadership position in the food delivery industry.

Sysco has continued to drum up business in the last quarter, winning bids for more than $1 billion of new business. The company has also been aggressive in reducing costs. Sysco reduced expenses by $500 million, including $300 million of permanent expenses, during the fourth quarter alone.

Sysco also managed to makes adjustments to its business and worked to create new sources of revenue. The company assisted restaurant customers with setting up pop up shops located in front of dinning rooms. Nearly 16,000 clients set up these marketplaces. Sysco even put customers in touch with those that could help with patio extensions, outdoor dining, website design, takeout menu production and to-go containers to aid in delivery.

The company said that these restaurants performed considerably better than its clients that did not work with Sysco on these concepts. Sysco also provided cleaning and sanitation products to customers.

This enabled Sysco to find additional revenues for its business while helping clients have a better chance of staying in business. So, in effect, this was both a short-term and long-term benefit to the company.

This work led to a 900-basis point improvement in a single quarter for Sysco's Net Promoter Score, a measurement tool used to determine the loyalty or likelihood that a customer will recommend a business to a friend. Higher NPS has led to higher customer retention rates in the past, which often leads to higher sales.

Sysco also focused on creating partnerships with regional grocers to provide fresh produce and proteins. With the company's size, they can purchase these items at lower costs. This allows Sysco to sell to grocers at a lower price point, saving those customers money.

No doubt about it, Sysco's quarter was ugly. The company was severely impacted by the ongoing pandemic. The company has an estimated 16% market share for food delivery in the U.S. Leadership did mention on the conference call that sales improved each week from May through June.

Under more normalized conditions, the company has been an excellent performer. Adjusted EPS grew at a rate of 14% annually from fiscal 2015 through fiscal 2019.

The company also performed well during the 2007 to 2009 recession as EPS improved 10% during this span. This shows that Sysco has endured other difficult periods of time and still shined.

The short-term might be rough for the company, but looking at all of the work Sysco put into creating new ways to create revenue while cementing bonds with customers both new and old will go a long way in creating growth following a recovery from the pandemic. This will make the post-recovery Sysco stronger and could allow the company to continue its impressive dividend growth streak.

Dividend and valuation analysis

Sysco has increased its dividend for 50 years. The company's dividend has grown with a compound annual growth rate of:

  • 5.6% over the past three years
  • 5.2% over the past five years.
  • 4.4% over the past 10 years.

Sysco's dividend CAGR rate has been increasing slightly over the above time periods, but has remained low. Investors were likely surprised when the company increased its Jan. 23 dividend payment by more than 15%. This was one of the largest increases in some time and also confirmed Sysco's status as a Dividend King, which are those stocks with at least five decades of dividend growth.

Shares yield 2.8% as of Tuesday's close. This compares favorably to the stock's five-year average yield of 2.5%, but is below the 10-year average yield of 3%.

Shareholders of the company will receive $1.80 in dividends in 2020. Based on EPS results for the most recent fiscal year, the payout ratio was 90%. Using estimates for the next fiscal year, the payout ratio exceeds 100%. A payout ratio anywhere close to this level is usually a situation you want to avoid, but the Covid-19 pandemic has severely hampered Sysco's operations.

Given my optimism for the company's growth prospects, I am willing to give Sysco a pass on this year's EPS payout ratio. The company's average payout ratio since 2010 is just 56%, showing that the dividend is normally well managed.

The free cash flow payout ratio looks a bit better. Sysco distributed $228.3 million in dividends last quarter while generating $423.7 million of free cash flow for a payout ratio of 54%.

Fiscal year dividends totaled $856.3 million while free cash flow was $898.3 million for a payout ratio of 95%. Normally, this would be a concern, but in my opinion, it is no cause to worry as long as the company can resume strong growth following the pandemic.

The three pervious fiscal years saw almost $2.2 billion of dividends distributed while free cash flow was $4.7 billion for an average free cash flow payout ratio of 47%.

I would expect that Sysco's EPS and free cash flow payout ratios will look more like the historical averages than this quarter's or fiscal year results in future years given its business strengths.

Sysco trades for approximately $64, giving the stock a forward price-earnings ratio of 36.2 based on earnings estimates for fiscal 2021.

Analysts seem to agree with my assessment, as the average of the EPS estimates for fiscal year 2022 is $2.96, which is a price-earnings ratio of 21.6 using the most recent closing price. Additional headwinds could materialize in a year of course, but the stock should be more attractively valued in the future.

Shares have traded with an average price-earnings ratio of 22.9 and 20.7 over the last five and 10 years, respectively, so the stock is expected to trade more in range of its previous averages.

Final thoughts

Sysco made the best of a bad situation in the fourth quarter of its fiscal year. Revenue and EPS plummeted, but this was due to factors outside of the company's control. Sysco did work with partners to try to assist them in creating sales and was quite successful at doing so. The company also likely cemented its relationship with those customers who were able to survive this difficult time.

Sysco has one of the longest dividend growth streaks in the market and offers a yield that is above its five-year average. This yield is almost a full percentage point higher than the average yield of the S&P 500. This forward price-earnings ratio is rich, but the company should benefit from an eventual recovery for restaurants.

For all of these reasons, I am quite optimistic about the company's future. I feel that long-term investors could consider adding Sysco at the current price.

Author disclosure: the author has no position in Sysco Corporation and has no plans to initiate a position in the next 72 hours.

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About the author:

Nathan Parsh
I am originally from the Detroit, Michigan area, before moving to Maryland to begin a career as an educator. This is my 15th year teaching. My wife and I have two young children who keep us on our toes.

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