The tough times for the restaurant industry continue. Once solid quick-service restaurants like McDonald's (NYSE:MCD) and Chipotle Mexican Grill (NYSE:CMG) have seen softer traffic patterns lately, and big food service equipment companies like Middleby (Nasdaq:MIDD) and Illinois Tool Works (NYSE:ITW) continue to report soft spending from restaurants. Sysco (NYSE:SYY) has been losing some of its shine in recent quarters, as the company struggles to leverage its much-heralded market share and infrastructure into real profit growth. Unfortunately for shareholders, not only does the near-term environment still look tough, but the share price may not yet fully account for that.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

A Little Optimism to Close the Fiscal Year
Sysco's final fiscal quarter looked reasonably good on paper, though investors should keep their enthusiasm reined in a bit.

Revenue rose 6% as reported, with real sales growth of 2.5%. That marks a sequential improvement from 1.6% real growth in the fiscal third quarter. Food inflation came in a little over 3%, while case volume increased 3.3%. Not only was this also better on a sequential basis (case volume rose 2.3% in the fiscal Q3), but it was better than the slightly negative overall restaurant comp decline for the Q2 (about 0.2% according to Knapp Track).

Profitability remains pressured, even if slightly less so than analysts feared. Gross margin fell about half a point from last year, while rising almost as much sequentially. Operating income fell 4% (though operating margin improved sequentially) and EBITDA declined for the third straight quarter.

SEE: Everything Investors Need To Know About Earnings

Droughts Don't Help Stability
Sysco management has spoken before of its desire for a relatively stable level of food price inflation, but that looks like it may not materialize in 2013. With the U.S. drought spiking corn prices, there are real worries about the degree of price increases that protein producers like Tyson (NYSE:TSN), Smithfield (NYSE:SFD) and Pilgrim's Pride (NYSE:PPC), and dairy producers like Dean Foods (NYSE:DF), will be contemplating next year.

It's hard to see how this doesn't hurt Sysco one way or another. Either the company will have to absorb some of the inflation (hurting margins), or it will see a mixed shift to lower-cost products (hurting margins) and/or lower overall order volumes (hurting margins).

SEE: A Look At Corporate Profit Margins

Long-Term Inevitability Versus Expectation
By no means do I think Sysco has any meaningful long-term problems with its business or its business model. Americans will continue to dine out, and Sysco's sheer operating scale gives it a real advantage over rivals. In other words, I think Sysco can see not only a growing addressable market, but continue to increase its share of that market.

SEE: "Healthyfying" The Fast Food Market

The Bottom Line
That said, I really don't see how the shares are undervalued today. Even if Sysco can add 50 basis points of free cash flow yield over the next five or so years (a lot for a company like this) and keep revenue growing at a 5% clip, it takes a low discount rate (8.5% or so) to generate a fair value of $35 - and even that isn't really compelling undervaluation. Although it's not at all uncommon to see high-quality companies sport healthy valuations, particularly when there are sizable barriers to entry, and today's environment really doesn't show what the company can do, it still seems like Sysco stock could find slow going for the foreseeable future.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  7. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  9. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  10. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  5. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  6. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!