It's a little scary when even some of the most efficient operators have difficulties cutting their costs enough to keep growing. That would seem to be the case today with Sysco (NYSE:SYY). It seems odd to read analysts criticizing Sysco's cost structure, but the reality is that growth has become more challenging for this proven dividend champion.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Costs Chewing into Profits
Sysco posted revenue growth of over 9%, but that number is a little misleading. Two-thirds of the company's growth was a byproduct of food cost inflation and actual case volume growth was more on the order of 3% with real organic growth closer to 2%. (For related reading, see What You Should Know About Inflation.)

Unfortunately, Sysco struggled to pass those costs on to its customers. As a result, gross margin slid about 80 basis points from the year-ago level. Sysco was also not able to trim its operating costs enough to compensate for its aggressive pricing. Operating income dropped about 2% as operating margin contracted 50 basis points.

Finding the Balance Between Price and Volume
Listening to management talk about the quarter, it looks like the company was willing to be more aggressive on pricing to drive volume. At the same time, investors shouldn't kid themselves about the pricing environment. Tyson Foods (NYSE:TSN) recently reported earnings where there were double-digit price increases across the protein spectrum and protein is close to 25% of Sysco's sales base. It's not just Tyson either, as most food companies are reporting price growth in the mid-single digits (at a minimum).

How Efficient Can Sysco Be?
Sysco has been relentless over the years when it comes to driving costs of its system. Now, though, investors are lamenting the company's cost structure and blaming that for the company's fiscal second quarter performance. This raises the question of what more the company can do. It's true that there's a decentralized structure at Sysco, but doesn't a national distribution business have to be decentralized to some extent?

There aren't many public companies that do what Sysco does, so comps are hard to come by. Nevertheless, Sysco does do better than United Natural Foods (Nasdaq:UNFI) and SuperValu (NYSE:SVU) when it comes to margins and returns, so it's worth asking just how much more Sysco can do to streamline its already-lean operations.

Stuck in the Middle
It's also worth noting that Sysco can only push customers so far in the present environment. Restaurant sales are about two-thirds of the company's customer base and people just aren't eating out as regularly as before the recession. What's more, when people do eat out, they are tending to go more to chain restaurants (25% of Sysco's customer base) that have value-priced or promotional meal deals.

What that means, then, is that Sysco has to press on companies like McDonald's (NYSE:MCD), Yum Brands (NYSE:YUM) or Ruby Tuesday (NYSE:RT) to drive better margins. With all of these companies likewise working to preserve their own margins, there just isn't that much slack left in the system. (For related reading, see How To Analyze Restaurant Stocks.)

The Bottom Line
Sysco is rarely ever cheap, as it is practically a permanent fixture in lists of blue-chip dividend stocks. Right now, the stock seems a little below fair value, but not to such an extent that's really exciting or interesting. Sysco remains a worthwhile holding for conservative income-oriented portfolios, but it's not an especially interesting stock today from a capital gains perspective.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

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

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  9. 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.
  10. 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.
  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. PT (Perseroan Terbatas)

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

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  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!