EUR 850.00 For Business Accounts Only

Morningstar | Sysco Withstands Headwinds to End Fiscal 2018 on Solid Ground; Shares Far From a Bargain

We expect a low- to mid-single-digit uptick to our $55 fair value estimate (primarily due to additional cash generated since our last update) for narrow-moat Sysco following fourth-quarter results (6.2% reported sales growth and 41 basis points of operating margin expansion to 5.04%) that evidence its scale advantages and low-cost position. Despite these gains (which ran in stark contrast to the pressures cited by no-moat US Foods, which fell victim to a retreat in volumes), we don’t foresee a material change to our long-term expectations, though, calling for 3%-4% annual top-line growth and operating margins of about 5%. Shares shot up around 7% on the news and continue to strike us as quite elevated, particularly in light of the intensely competitive landscape and macro challenges that could constrain its trajectory.

In a shift from the recent past, management cited more modest inflationary pressures than earlier in the year (clocking in at just 1.1%), concentrated within dairy, frozen potatoes and vegetables, and paper and disposable products. But even in the face of a more pronounced acceleration in costs or more aggressive pricing actions by peers, we believe Sysco now has a better grasp on its cost structure, as evidenced by the 5.7% growth chalked up in adjusted gross profit (on top of 4% growth a year ago) that far outpaced the just 2.5% increase in adjusted operating expenses. Favorable mix also aided margins, as higher-margin local case growth (to 3.6%) and increased penetration of Sysco brand sales (now accounting for nearly half of its sales) bolstered profits. And we anticipate that further strides to enhance its supply chain capabilities and more efficiently use technology across the organization (as part of efforts to drive $650 million-$700 million of operating income improvement through the end of fiscal 2020) should ensure gross profit growth above operating expense growth persists longer term.

Regarding capital allocation, we suspect Sysco will direct a portion of its free cash flow (which amounted to nearly 3% of sales in fiscal 2018) to remain a consolidator in the fragmented foodservice distribution space, both at home and abroad. However, we don’t portend the firm will merely chase growth, but rather will continue to act as a prudent steward of shareholder capital. Over the course of its history, Sysco's deal making has included more than 150 transactions, and going forward, we surmise that Sysco will pursue smaller bolt-on deals to build out its footprint and enhance its scale, with an interest in acquiring more specialized players that possess a focus on select geographies or categories, similar to its historical bent. Management anticipates acquisitions will contribute around 1% to sales growth each year--in line with its past performance and our forecast.