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Morningstar | Labor Cost Inflation Constrains No-Moat Performance Foods' Profits and Shows Little Sign of Abating

Performance Food is the third-largest player in the potential $300 billion food-service distribution market, behind narrow-moat Sysco and no-moat US Foods. It holds around 6% share of the market. The firm is shifting away from primarily catering to large restaurant chains (which boast a compressed profit opportunity) in favor of increasingly serving smaller, independent chains. And while we maintain a positive view of the firm’s focus on expanding its position with these operators, which tend to be higher-margin sales than chain restaurants given the increased service requirements, we don’t expect these gains to come uncontested, as Sysco and US Foods target the same group.The firm has combined these traditional routes with its Vistar business (around 20% of sales), which includes the distribution of higher-margin immediate-consumption goods that are outside a typical food distributor’s scope. These vending machine and small-pack products could be replicated by larger rivals like Sysco and US Foods, but PFG holds a minor competitive advantage over smaller rivals because inventory requirements would be much harder for smaller firms to replicate. We contend the previously announced deal to add privately held Eby Brown, a wholesale consumer product distributor, under its umbrella should support further gains in this arm of its operations. In this vein, and like its larger rivals, we expect PFG remains hungry for acquisitions as a means to support its scale and enhance its product offerings over time. The industry is made up of around 15,000 smaller domestic distributors, setting the stage for the leading operators to serve as consolidators for years to come. As such, we forecast acquisitions will boost PFG's annual sales by 0.5%-1% (in line with other leading operators). Further, we surmise Performance will use value-added services like data analytics, consulting, and e-commerce to expand its underlying sales base. We believe these services are increasing the technology curve in the industry, placing further strain on smaller rivals that lack the resources to invest. However, we view this more as a cost of doing business than as facilitating a competitive edge.