Sysco Humming Along

By Stephen D. Simpson, CFA | May 11, 2011 AAA

Food distributor Sysco (NYSE:SYY) is never flashy, but the company has an enviable track record of market share growth and consistent free cash flow growth. That makes it a staple name on lists of quality dividend growth stocks and conservative growth ideas. What's more, it is not a bad way to play what could prove to be many years of inflation pressure. (To help you build a dividend portfolio, read Build A Dividend Portfolio That Grows With You.)

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Solid Third Quarter Performance
Sysco reported sales growth of just over 9% for its fiscal third quarter, quite a bit better than the consensus expectation of just under 6%. Growth was clearly fueled by food inflation of more than 5%; case volume growth was about 2% and real sales growth was just under 3%. That is relatively consistent with the customer traffic patterns being reported by major U.S. restaurant chains like McDonald's (NYSE:MCD) and Brinker (NYSE:EAT), so there is not much reason to think that Sysco is losing share.

Profitability continues to be a bit more challenging, though. Gross margin slid about 30 basis points this quarter, and Sysco picked up a bit of that through the operating expenses, as operating expense grew a little more than 7% and operating margin slipped about 10 basis points. (For help, check out Understanding The Income Statement.)

How Far Can Sysco Push?
Sysco has a great deal of leverage when it comes to pushing along its higher costs. Restaurants thrive on consistency, and they are not going to drop Sysco lightly. By the same token, restaurants are getting squeezed between higher food and fuel costs (distributors like Sysco tack on fuel surcharges) and higher capital equipment costs from companies like Middleby (Nasdaq:MIDD) and Manitowoc (NYSE:MTW).

At some point, then, something has to give. Restaurants will delay capital equipment spending as long as they can, but the intense pressure of value menus from quick-service chains and prix fixe offerings from brands run by Brinker, Darden (NYSE:DRI) and DineEquity (NYSE:DIN) limit how much cost inflation they can push on to their customers. Along similar lines, though, is the threat that a rival like Performance Food Group or U.S. Foodservice will absorb some of that inflation themselves to gain share. (To help you fight food cost, see 22 Ways To Fight Rising Food Prices.)

Looking to Go Overseas
Sysco is hoping that it can replicate its success overseas. There are plenty of restaurants and food service operations in other countries, and it should be a growth industry in emerging markets as standards of living improve. That said, it takes time and money to build the distribution networks, and this will be a slow process that will take years to show real results.

The Bottom Line
Sysco's popularity with the dividend and conservative growth crowds means that it rarely falls to a compelling valuation point. The same is true today. Investors buying Sysco today can probably look at 10% appreciation before reaching fair value. Remember, though, that Sysco pays better than a 3% dividend and should be able to grow free cash flow at a mid-single digit rate for the long term. All in all, then, that's a setup for market-equivalent growth with below-average risk, and that is not a bad combination. (To learn more about growth stocks, check out The Power Of Dividend Growth.)

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