Sysco (NYSE: SYY ) has just experienced a significant decline to around $32.20 per share. Interestingly, famous investor Donald Yacktman accumulated shares of Sysco for both of his funds, Yacktman Fund and Yacktman Focused Fund, in the second quarter 2013. Should investors consider the recent drop as a good buying opportunity? Let's dig deeper and find out.
Sluggish fourth quarter results
The recent decline in Sysco's stock price was due to the sluggish fourth quarter earnings results. In the fourth quarter, Sysco increased its sales by around 5.4% to $11.6 billion, but its operating income dropped 10.8% to nearly $460 million. The diluted EPS came in at $0.47 per share, 11.3% lower than the EPS of $0.53 in the fourth quarter of last year. The drop in earnings was due to the increasing food cost inflation and the rising costs relating to business transformation and restructuring items. Sysco's fourth quarter EPS of $0.47 missed analysts' expectations of $0.54. For the full year, Sysco generated around $1.78 in EPS, which was also lower than analysts' estimates of $1.83 per share.
Strong balance sheet with consistently growing dividends
What investors might like about Sysco is its strong balance sheet and consistently-growing dividend payments. As of June 2013, it had $5.2 billion in equity, $412.3 million in cash and nearly $2.64 billion in long-term debt. The net debt/EBITDA came in at a reasonable amount at 1.42. Furthermore, it has a good dividend payment history. In the past ten years, it has consistently increased its dividends, from $0.42 per share in 2003 to $1.07 per share in 2012. At $32.20 per share, it is worth $18.90 billion on the market. The market values Sysco at 8.4 times its trailing EBITDA. At the current trading price, Sysco yields 3.50%.
Sysco has been spending a lot of effort on business transformation, including cutting SG&A costs, enhancing productivity and improving information technology. It expects to realize as much as $550-$650 million in annual business transformation benefits by fiscal 2015. Because Sysco has exceeded the 2013 target of realizing 25% of the total above-mentioned target in fiscal 2013, the probability for Sysco to deliver $550-$650 million in annual benefits in the next two years is quite high. However, due to rising costs and weak customers demand, the near-term outlook for Sysco is not very encouraging.
Nevertheless, in the long run I am still bullish about Sysco, with its huge economies of scale. It possesses a large distribution network, serving as many as 400,000 customers in North America. Consequently, Sysco seems to have a wide moat that cannot be matched by other smaller players, including United Natural Foods (NASDAQ: UNFI ) and Core-Mark (NASDAQ: CORE ) .
How about the competitors?
United Natural Foods is the most expensive among the three companies. It is trading at $62.10 per share, with a total market cap of around $3 billion. The market values United Natural Foods at as high as 14.8 times its trailing EBITDA. United Natural Foods has a narrower customer base, with 27,000 customer locations in the U.S. and Canada, and it has more than 65,000 different products. Interestingly, what United Natural Foods focuses on is organic and natural products. It has been the main supplier of natural and organic products to Whole Foods for more than 12 years, and its existing contract with Whole Foods will not expire until September 2020. United Natural Foods is growing its business by expanding its customer base, with new conventional supermarket customers, increasing market share of existing customers' business, improving the distribution network's efficiency and pursuing acquisitions for further business expansion. For the full year, United Natural Foods expects to grow its revenue by 15.2%-15.7%, to $6.03-$6.06 billion, with the diluted EPS being in the range of $2.12-$2.14
Core-Mark is a bit more expensive than Sysco. At $66.70 per share, Core-Mark is worth around $768 million. The market values Core-Mark at 9.7 times its trailing EBITDA. Core-Mark, the marketer of fresh and supply solutions to the convenience retail industry, is currently serving more than 28,000 customer locations in 50 states in the U.S. and five provinces in Canada. Cigarettes are the company's main revenue contributor, accounting for 49% of the total 2012 revenue, whereas the non-cigarette products keep driving profits. In 2012, non-cigarettes products represented 68% of the total gross profit in 2012.
Looking forward, Core-Mark plans to grow its business through both market share gains and acquisitions. The company reported that it was seeing dollar stores and drug stores were selling items that used to be sold in convenience stores. The blurring of the different retail channels could create opportunities for Core-Mark. In the future, it will also spend its efforts on increasing market share in the traditional C-store space, including Turkey Hill and Rutter's. For the full year 2013, Core-Mark expects to generate around $55 –$60 million in free cash flow.
Core-Mark seems to be a good stock for investors to hold in a long run, with a low valuation and the potential business growth. It also offers investors some dividends with a yield at 1.10%. Core-Mark has a much lower payout ratio at only 25%. If Core-Mark raises the dividend payout ratio to 63%, equivalent to Sysco's payout ratio, Core-Mark could yield as much as nearly 2.80%.
My Foolish take
Long-term income investors should pick Sysco for their portfolios, because of its market leading position, the wide moat of a large distribution network and a nice dividend yield. The business could suffer in the short-run, but in a long run, I still think it will deliver a decent return to shareholders.
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