Sysco’s Industry-Leading Scale Drives Continuous Profit Growth

Sysco Inc. (SYY) joined my long list of ideas in December 2017, and I included it in the “See Through the Dip” thesis in April 2020. The stock outperformed the market before COVID but gained momentum. late since. However, the country’s largest food service provider is outperforming the competition and taking market share. As I will show in this report, the stock could be worth $ 103 / share today.

The advantage of scale gives more potential to Sysco’s actions

  • Sysco’s 3Q21 earnings reveal that the company’s “divide” is growing and could lead to years of earnings growth. An extensive and efficient distribution network coupled with a large base of existing customers are important drivers of Sysco’s value.
  • Sysco’s scale enables it to mitigate supply chain disruptions by serving its customers. Management notes that it is able to “provide higher fill rates for customers than the industry average”. The company added 25,000 points of service in fiscal 2021 and management said in the fiscal year 1Q22 earnings call “we are winning more new business than at any time in history. of the society “.
  • Assuming a return to pre-COVID margins and consensus earnings estimates, the stock is now worth $ 103 / share, or 41% above the current price.

Figure 1: Performance of long ideas: from publication date to 11/16/2021

What works for the business

Income is rising above pre-pandemic levels. Sysco exceeded expectations for the first quarter of fiscal year 1Q22, reporting a 40% year-over-year (YoY) revenue increase. Top quarter revenue 8% higher than pre-pandemic 1Q20 fiscal year levels (13 weeks ended September 28, 2019). The company also provided preliminary October sales results showing a 10% increase from 2019 levels.

Going back to Catering, on and off site, is driving demand. Returning customers to restaurants led to increased consumption of paper and disposables that drove Sysco’s year-on-year revenue gains. Sales of the company’s paper and disposables segment grew 29% year-on-year, while its overall foodservice business in the United States grew 46% year-on-year. Sales in the company’s SYGMA segment, which encompasses its distribution operations in the United States for quick-service restaurant chains, increased 12% year-on-year and are 18% above fiscal 1Q20 levels. .

Growing market share. I noted in my April 2020 report that the pandemic gave Sysco the opportunity to grow its market share through smart acquisitions. In fiscal 1Q22, Sysco acquired Greco and Sons as the company seeks to expand its presence in the fast growing industry specialty food segment. The company plans to expand Greco & Sons nationwide through the Sysco network and create an Italian segment platform nationwide. Management expects the acquisition to contribute $ 1 billion (2% of fiscal 2021 revenue) to fiscal 2022 revenue.

In addition to acquisitions, Sysco’s strong sales team and superior distribution network are integral to the growth of its existing operations. After adding 25,000 points of service in fiscal 2021, a 4% year-over-year improvement, the company continues to gain new customers at a rapid pace. In his call for the results of fiscal year 1Q22, the company said, “We are winning more new business than at any time in the history of the company,” resulting in market share gains. Sysco’s share of the US foodservice market has grown from 16% in 2019 to 17% in 2020. In addition, the company estimates that it is on track to grow by 1 , Twice the market in fiscal year 2022.

Sysco is bigger and more profitable than its peers. Sysco’s TTM after-tax net operating margin (NOPAT) fell from 1% in 3Q21 to 3% in 1Q22, while its invested capital improved from 2.8 to 3.6 during the same period. period. The increase in NOPAT’s margins and the rotations of invested capital increase Sysco’s TTM return on invested capital (ROIC) from 3% in 3Q21 to 10% in 1Q22. According to Figure 2, Sysco’s ROIC is twice that of its closest counterpart.

Figure 2: Profitability of Sysco vs. Peers: TTM

What doesn’t work for the business

International exposure slowed down the takeover of Sysco. The disruptions related to COVID-19 had a greater impact on the company’s international activities (16% of sales in fiscal year 2021) than on its other segments. Sysco’s international sales remain less than 1% below fiscal 1Q20 (pre-pandemic) levels, but grew 34% year-over-year in fiscal 1Q22.

Order fulfillment rates need to improve. Supply chain issues have plagued the entire restaurant industry, and Sysco admits its fill rates are below historical standards. However, given Sysco’s scale, the company experiences less disruption than its peers, and management notes that it is able to “deliver higher fill rates for customers than the industry average.” The company’s ability to serve its customers even in a tough environment contributes to the market share it has gained in each of the past 10 months.

A tough job market could disrupt operations. While the tough job market may pose a threat to Sysco’s operations going forward, the company is not experiencing a major staff shortage at this time. Before the tensions in the job market, Sysco already offered competitive salaries and has since streamlined its hiring process. The company’s efforts to attract employees appear to be paying off, and at a one-day national recruiting event in October, the company hired 1,000 employees.

However, if the labor market tightens further, labor costs could be a barrier to Sysco’s operations.

Inflation remains a threat. Higher inflation levels also create barriers to Sysco’s profitability if it is unable to pass higher costs on to its customers. So far, the company notes that it “hasn’t seen much of a pullback in our ability to pass prices” and recently rolled out a new pricing tool that can dynamically pass increases in inflation to items. specific customers. Management expects inflation to hold at current rates through fiscal 2Q22 before easing later in the year.

Sysco valued for historically low earnings growth

Below, I use my company’s Reverse Discounted Cash Flow (DCF) model to analyze future cash flow growth expectations built into a few stock price scenarios for Sysco.

In the first scenario, I assume that Sysco:

  • NOPAT’s margin is back to pre-pandemic levels of 3.7% compared to fiscal year 2022-2031, and
  • revenue increases by 8% compounded annually from FY 2022-2024 (compared to the consensus CAGR of 12% for FY 2022-2024), and
  • revenue increases 5% compounded annually from FY 2025-2031 (equal to Sysco’s 10-year pre-pandemic revenue CAGR for FY 2009-2019 and below expected industry growth until 2026)

In this scenario, Sysco’s NOPAT increases by 4% compounded annually from pre-pandemic fiscal year 2019 through fiscal year 2031 and the share is worth $ 76 / share today – close to the current price. Discover the math behind this reverse DCF scenario. As a benchmark, Sysco increased NOPAT by 6% compounded annually from fiscal year 2009-2019.

Sysco’s big divide means stocks could hit $ 103 or more

My company’s reverse DCF model allows me to take into account Sysco’s considerable gap, which is reinforced by its distribution network and existing customer base, by assessing its Appreciation Period for Growth (GAP). GAP represents the number of years that Sysco can grow while achieving ROI greater than its Weighted Average Cost of Capital (WACC). Warren Buffett calls the moat around a company’s castle GAP.

The following valuation scenario assumes a 15-year GAP, which may prove to be a conservative assumption due to the strength of Sysco’s expanding gap.

If I assume that Sysco:

  • NOPAT’s margin is back to pre-pandemic levels of 3.7% compared to fiscal year 2022-2031, and
  • revenue increases by 12% compounded annually from FY 2022-2024 (equal to the consensus CAGR of 12% for FY 2022-2024), and
  • revenue increases 4% compounded annually from FY 2025-2036 (lower than Sysco’s 15-year pre-pandemic revenue CAGR for FY 2004-2019), then

the share is worth $ 103 / share today, or 41% above the current price. Discover the math behind this reverse DCF scenario. In this scenario, Sysco’s NOPAT CAGR for fiscal year 2019-2036 is 4%. If Sysco’s GAP extends beyond 15 years, the title has even more potential.

Figure 3: Historical and implicit Sysco NOPAT: DCF valuation scenarios

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation for writing about a specific stock, industry, style, or theme.


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