EUR 850.00 For Business Accounts Only

Morningstar | Labor Costs Constrain Performance Food Group's Profits in 3Q; Shares Still Lofty

Performance Foods' shares retreated to the tune of a mid-single-digit percent following third-quarter results that included 3% organic case growth and a 10-basis-point erosion in adjusted operating margins to 1.4%. We attribute the market reaction to the profit pressure eating into its already modest margins and management’s cautionary tone surrounding the added costs to attract and retain labor (particularly within its delivery and warehouse operations). However, with just one quarter remaining in its fiscal year, Performance marginally tightened its adjusted EPS forecast to $1.73-$1.79 (which aligns with our $1.78 outlook), versus $1.70-$1.79 prior (partly as the shift to higher-margin independent restaurants has been accretive). Although we expect to lift our $29.50 fair value estimate by about $1 to reflect the time value of money, we view shares as a bit rich (trading at about a 25% premium to our assessment of the no-moat firm’s intrinsic value).

While intense competitive pressure and cost inflation stemming from higher transportation and labor costs have yet to abate (dampening prospects within its foodservice arm that accounts for 80% of sales), we aren’t blind to the traction the firm continues to boast in its Vistar operations (20% of sales, which services theaters, vending machines, and retail) with top-line growth of nearly 9% in the quarter. We haven’t wavered in our thinking that this segment is poised to aid the firm’s overall profit profile, with margins around double the corporate average. And we contend the previously announced deal to add privately held Eby-Brown, a wholesale consumer product distributor, under its umbrella should support further gains. We forecast average segment sales and profit growth will amount to 8% and 9%, respectively, over the next 10 years. This underlies our outlook for the consolidated business or around 4% average annual sales growth and 60 basis points of operating margin improvement over the next decade to 2%.

And despite this recent tie-up, we don’t believe the firm’s appetite for acquisitions has been squashed. Rather, we think it will remain a consolidator in this fragmented and competitive space, which should support its scale and enhance its product offerings. The domestic food-service industry boasts around 15,000 smaller domestic distributors, setting the stage for the larger firms to serve as consolidators for years to come. However, given competitive pressures in this mature category, we don’t expect any potential tie-ups will come uncontested--as Sysco and US Foods are pursuing similar strategies to aid their respective positions. Despite this, we don’t posit Performance will abandon its past strategic bent and should remain a prudent steward of shareholder capital.