EUR 850.00 For Business Accounts Only

Morningstar | US Foods Trucking on With Efforts to Right-Size Its Cost Structure in 3Q; Shares Not a Bargain

While US Foods’ shares jumped at a low-double-digit clip in response to third-quarter results (which included a 0.8% dip in sales, 60 basis points of adjusted gross margin gains to 17.9%, and 20 basis points of adjusted operating margin improvement to 3.2%), we believe this reaction fails to account for the robust competitive and cost headwinds that persist throughout the industry. And even though we intend to edge up our $29.50 fair value estimate by a low-single-digit rate to account for additional cash generated since our last update, we think investors should await a more attractive risk/reward opportunity before building a position in this no-moat name.

Over the last several quarters, US Foods has undertaken actions to drive efficiencies across the organization (particularly within its supply chain and distribution), and these efforts appear to be gaining traction, as evidenced by the 2.2% bump chalked up in adjusted gross profit dollars that outpaced the 1.5% uptick in adjusted operating expenses. However, like its narrow-moat peer, Sysco, US Foods cited higher fuel and wage costs as a challenge. Given these cost pressures are structural in nature--stemming from the recent truck driver shortage that is taking a toll on firms throughout a number of industries--we don’t expect these inflationary trends will subside over the near term.

However, beyond extracting excess costs, we view the firm’s efforts to shift its mix to higher-margin independent restaurants as advantageous, given these customers tend to value the added services distributors like US Foods are able to offer, as opposed to national chain restaurants that maintain an outsize focus on price and, as such, offer less in the way of profitability. This undertaking is not only aiding the firm’s profit profile but also its case volume growth, which was down 1% on an organic basis for the total company in the quarter but up 3.1% within its mix of independent restaurants.

From a capital allocation perspective, US Foods is still working to gain regulatory approval for its pending tie-up with SGA that was announced in July. We continue to see the strategic merit of the deal (and thus aren’t wavering on our Standard stewardship rating), as the purchase stands to build out US Foods' scale, enhancing its geographic footprint in the Northwest, and expanding its base of private-label offerings. While the deal will push pro forma leverage to around 4 times, we expect US Foods will delay share repurchases and direct free cash flow to pay down debt, targeting 3 times by fiscal 2020, which we think is attainable. From our vantage point, US Foods’ prime focus is likely to center on integrating this business and reducing leverage for the next few years, but we believe that longer term, it will remain a consolidator in this highly fragmented industry.