It's not especially fun to watch a one-time blue chip lose its luster, but there's no point in denying that that's what's happening with Sysco (NYSE:SYY) right now. While Sysco is still the dominant food distributor in the country, that dominance seems to be worth less and less as investors see the limits of the company's ability to fight against the tide. This company will have its good days again, but I would suggest that the premium that the company has long enjoyed for its market power and stable growth should be re-evaluated.
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More of the Same in Third Quarter
Not a lot changed in Sysco's third quarter, and that's unfortunate given the recent trends in the business. Revenue rose more than 7% as reported, while "real" revenue growth was closer to 2%. Organic case volume of 2.3% was not bad, given that overall restaurant traffic was down a bit in the quarter.
Cost inflation continues to be a major factor in this story. Sysco reported 5.5% food cost inflation as part of its revenue growth, fueled in part by the double-digit price increases that companies like Tyson (NYSE:TSN) and Smithfield (NYSE:SFD) have pushed through in proteins. Other cost items like fuel and bad debt are also taking their toll, though.
Gross margin slipped a point from last year, and reported operating income fell 5%. While core expenses were up about 3% (as opposed to the nearly 5% reported increase), the company is under pressure on several fronts. Not only is the company still struggling to implement a new ERP system, but the numbers suggest that even mighty Sysco has to use aggressive pricing to protect market share.
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Too Many of the Wrong Customers?
Food cost inflation, ERP implementation difficulties and restaurant traffic trends are known issues. I also wonder, though, if the changing dynamics of the restaurant industry are taking their toll. Quick service restaurants (QSR) like McDonald's (NYSE:MCD), Panera (Nasdaq:PNRA) and Chipotle's (NYSE:CMG) are taking more and more share of the restaurant industry, pressuring not only locally-owned restaurants, but national chains as well.
Why would this matter? Well, Joe's Pizza is a price-taker when it comes to Sysco (outside of some ability to choose amongst other distributors), but McDonald's, Yum Brands (NYSE:YUM) and other large QSR chains have a great deal of more leverage when it comes to terms. I also wonder if the relatively more limited menus of QSRs is an issue as well - Sysco still has to maintain a large selection of product, but may be seeing more and more sales come from a narrow list of items where the margins are likely narrower.
Can Sysco Reclaim the Execution Story?
Sysco has long been a story dominated by the company's seemingly limitless ability to drive more efficiencies and synergies through aggressive cost-containment and mergers and acquisitions. Now the company seems to have run out of slack to take up.
To be fair, there are ample reasons to think that Sysco can recover and get back on its former track. This is still a very tough economy, with consumers turning to private label brands and QSR value menus to stretch their budgets. Hopefully this won't last forever. What's more, Sysco's competitors lack the same scale and synergies and can only try to fight on price for just so long.
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The Bottom Line
Sysco' stock has been in a downward trend since early 2004, a trend that I believe has been fueled by valuation resets as the company's growth rate has increasingly started to match the market. These resets are painful for long-term shareholders, but companies like this often regain a growth trajectory that, while not matching the past, do provide solid long-term returns.
I'm not sure if Sysco's performance has finally shaken out the investors who believed the stock was worth a double-digit EV/EBITDA ratio, but valuation has definitely compressed. I don't think investors need to buy in today, but I think the stock is getting incrementally closer to becoming a solid long-term story once again.
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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.