Sysco () operates a market-leading distribution business spanning food, restaurant supplies and equipment to everyone who sells or creates meals. This includes hundreds of thousands of restaurants, schools, and hospitals that buy some of the hundreds of thousands or so products the company sells. According to the firm, Sysco owns nearly 20% share of this $200 billion+ industry, and it is hoping to increase this figure via large investments and by providing superior service in what we describe to be a highly fragmented industry.
As a result, we really like Sysco’s business model and prospects for gaining market share in the near future. Thus far, the company has focused on highly-populated markets in order to gain route density—which is an industry term for improving delivery efficiency. Route density is critical to Sysco’s cost advantage versus competitors; it saves both fuel costs and time costs. The company also has an enormous sales operation that its competitors simply cannot afford.
While we think Sysco should be able to expand its market share even further and eventually raise prices, we question whether or not the company will be able to pass on cost inflation to customers quickly enough to preserve its high levels of profitability. Texas Roadhouse (), for instance, lowered its food inflation forecast to 7% from 8%. With around 18% of Sysco’s sales coming from frozen fruit and meat, we worry that the push back from customers may prevent Sysco from raising prices. According to the Bureau of Labor Statistics, wholesale steak costs are up 12% compared to a year ago, which we think is Texas Roadhouse’s largest input, suggesting Sysco is absorbing some of that cost. Though Texas Roadhouse is but one customer, we think such trends may be prevalent across Sysco’s expansive customer base.
If feed prices for soy and corn come down over the next year, then we suspect meat prices in aggregate should fall as meat production rises. However, we are unsure if the timing of price easing will be able to allow Sysco to catch some of that profit margin. In the long run these price imbalances may cancel each other out, but in the coming periods, it could hurt the company’s ability to earn increased returns on invested capital. We think the effects of quantitative easing, volatile commodities and currencies could also obscure the value of the company as well. Additionally, the move towards organic and eating local could hurt some of Sysco’s key segments, including meat and poultry. Yet, we think this trend is still in its early stages and may not accelerate as much as expected because several parts of the US aren’t located near productive farmland. Therefore, we don’t think competitive pressure is significant enough to pressure the firm’s business model, at least over the near term.
Nevertheless, we like the long-term outlook for Sysco’s business model. According to the National Restaurant Association, which represents roughly 380,000 restaurants, the expectations for both hiring and business conditions in 2012 are optimistic. We suspect that a moderation in fuel prices will help drive additional traffic during the summer months. Further, the rise of “healthier” fast-serve food has helped expand the overall market for meals outside of the home. According to research from Arkansas’ Sam Walton School of Business, Americans now spend more than half of their food dollars on meals outside the home, and the trend shows no sign of slowing down.
Ultimately, Sysco operates a very attractive business in a very large market. Its dividend yield of nearly 4% looks sustainable, in our view, as the firm earns a Valuentum Dividend Cushion score of 1.3. We also think the company provides an opportunity for dividend growth, but the firm’s ability to increase free cash-flow remains challenging, in our view. As a result, we think firms with cash-rich business models like Microsoft () and Intel () are much more likely to increase their dividend payouts to shareholders at a more aggressive rate than Sysco. Further, at current levels, we think Sysco is fairly valued, so we do not see a huge amount of upside valuation at this time. The company’s Valuentum Buying Index score of 6 suggests that we’re growing constructive on the firm’s shares at these levels, but we think there are better investment opportunities available. Still, we think Sysco remains a strong candidate for our Dividend Growth portfolio.