Sysco’s Industry-Leading Scale Drives Continued Profit Growth

Sysco Inc. (SYY) joined my list of long ideas in December 2017, and I included it in the “See Through the Dip” thesis in April 2020. The stock outperformed the market before COVID but took delay since. However, the nation’s largest foodservice provider is outpacing the competition and taking market share. As I will show in this report, the stock could be worth $103/share today.

Scale advantage gives Sysco shares more upside

  • Sysco’s 3Q21 earnings reveal the company’s “moat” is growing and could lead to years of earnings growth. An extensive and efficient distribution network coupled with a large existing customer base are important drivers of Sysco’s value.
  • Sysco’s scale enables it to mitigate supply chain disruptions by serving its customers. Management notes that it is able “to offer customers fill rates above the industry average”. The company added 25,000 service locations in fiscal 2021 and management said on the 1Q22 earnings call “we are winning more new business than at any other time in the company’s history. business”.
  • Assuming a return to pre-COVID margins and sticking to consensus earnings estimates, the stock is worth $103/share today, or 41% more than the current price.

Figure 1: Performance of long ideas: from publication date to 11/16/2021

What works for the business

Incomes rise above pre-pandemic levels. Sysco beat revenue expectations in 1Q22, reporting a 40% year-over-year (YoY) revenue increase. Quarter revenue 8% higher than pre-pandemic fiscal year 1Q20 levels (13 weeks ended September 28, 2019). The company also provided preliminary October sales results showing a 10% increase over 2019 levels.

The return to catering, on-site and off-site, is stimulating demand. The return of customers to restaurants has led to increased consumption of paper and disposables which has boosted Sysco’s annual revenue gains. Sales of the company’s paper and disposables segment were up 29% year-on-year, while its overall U.S. restaurant operations were up 46% year-on-year. Sales for the company’s SYGMA segment, which encompasses its U.S. distribution business for quick-service restaurant chains, were up 12% year-over-year and 18% above fiscal 1Q20 levels.

Growing market share. I noted in my April 2020 report that the pandemic has given Sysco an opportunity to grow market share by making smart acquisitions. In fiscal 1Q22, Sysco acquired Greco and Sons as the company seeks to expand its presence in the fast-growing sector specialty food segment. The company plans to expand Greco & Sons nationwide across the Sysco network and create a nationwide Italian segment platform. Management expects the acquisition to add $1 billion (2% of fiscal 2021 revenue) to fiscal 2022 revenue.

In addition to acquisitions, Sysco’s strong sales team and superior distribution network are integral to growing its existing operations. After adding 25,000 service locations in fiscal 2021, a 4% year-over-year improvement, the company continues to win new customers at a rapid pace. In his call for 1Q22 results, the company said, “we are winning more new business than at any other time in the company’s history,” resulting in market share gains. Sysco’s share of the U.S. restaurant market has grown from 16% in 2019 to 17% in 2020. Additionally, the company estimates it is on track to grow 1.2 times the market over the past year. fiscal year 2022.

Sysco is bigger and more profitable than its peers. Sysco’s net operating profit after tax (NOPAT) TTM margin increased from 1% in 3Q21 to 3% in 1Q22, while its invested capital turnover increased from 2.8 to 3.6 during the the same period. Rising NOPAT margins and invested capital turnover drive Sysco’s return on invested capital (ROIC) from 3% in 3Q21 to 10% in 1Q22. According to Figure 2, Sysco’s return on investment is twice that of its closest counterpart.

Figure 2: Profitability of Sysco Vs. Peers: TTM

What’s not working for the business

International exposure has slowed Sysco’s recovery. The disruptions related to COVID-19 have had a greater impact on the company’s international activities (16% of revenue in fiscal 2021) than on its other segments. Sysco’s international sales remain

Order fulfillment rates need to improve. Supply chain issues have plagued the entire restaurant industry, and Sysco admits its fill rates are below historical standards. However, given Sysco’s scale, the company experiences less disruption than its peers, and management notes that it is able to “deliver higher fill rates for customers than the industry average.” ‘industry”. The company’s ability to serve its customers even in a difficult environment contributes to the market share it has gained in each of the last 10 months.

A difficult labor market could disrupt operations. While the tough labor market may pose a threat to Sysco’s operations in the future, the company is not experiencing any major staff shortages at this time. Prior to the pressure on the job market, Sysco was already offering competitive salaries and has since streamlined its hiring process. The company’s efforts to attract employees appear to be paying off, and in a one-day national recruitment event in October, the company hired 1,000 employees.

However, if the labor market tightens further, labor costs could represent a headwind for Sysco’s operations.

Inflation remains a threat. Higher levels of inflation also create headwinds for Sysco’s profitability if it is unable to pass on higher costs to its customers. So far, the company notes that it “hasn’t seen much pushback on our ability to pass on pricing” and recently rolled out a new pricing tool that can dynamically pass on inflation increases to items. specific customers. Management expects inflation to hold at current rates through fiscal 2Q22 before declining later in the fiscal year.

Sysco is priced for historically weak profit growth

Below, I use my company’s inverted discounted cash flow (DCF) model to analyze future cash flow growth expectations embedded in a few stock price scenarios for Sysco.

In the first scenario, I assume that Sysco:

  • NOPAT margin recovers to pre-pandemic fiscal 2019 levels of 3.7% from fiscal 2022-31, and
  • revenue grows 8% compounded annually from FY 2022-24 (compared to a consensus CAGR of 12% in FY 2022-24), and
  • revenue grows by 5% compounded annually from fiscal year 2025-2031 (equal to Sysco’s pre-pandemic 10-year revenue CAGR from fiscal year 2009-2019 and before) expected industry growth until 2026)

In this scenario, Sysco’s NOPAT increases by 4% compounded annually from pre-pandemic fiscal year 2019 to fiscal year 2031 and the stock is worth $76/share today – more than the current price. Discover the calculations behind this reverse DCF scenario. For reference, Sysco increased the NOPAT by 6% compounded annually from fiscal year 2009-2019.

Sysco’s big gap means shares could hit $103 or more

My company’s inverted DCF model allows me to account for Sysco’s considerable moat, which is bolstered by its distribution network and existing customer base, when assessing its Growth Appreciation Period (GAP). GAP represents the number of years Sysco can grow while earning a ROIC above its weighted average cost of capital (WACC). Warren Buffett refers to GAP as the moat around a company’s castle.

The following valuation scenario assumes a GAP of 15 years, which may prove to be a conservative assumption due to the strength of Sysco’s expanding moat.

If I assume that Sysco:

  • NOPAT margin recovers to pre-pandemic fiscal 2019 levels of 3.7% from fiscal 2022-31, and
  • revenue grows by 12% per year starting in FY 2022-24 (equal to the consensus CAGR of 12% for FY 2022-24), and
  • revenue grows 4% compounded annually beginning in FY 2025-36 (below Sysco’s 15-year pre-pandemic revenue CAGR of FY 2004-2019), then

the stock is worth $103/share today, or 41% above the current price. Discover the calculations behind this reverse DCF scenario. In this scenario, Sysco’s FY 2019-2036 NOPAT CAGR is 4%. If Sysco’s GAP extends beyond 15 years, the stock has even more potential.

Figure 3: Sysco Historical and Implicit NOPAT: DCF Valuation Scenarios

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation for writing about a specific stock, industry, style, or topic.