What Sysco’s New Competitive Advantage Means for Your Portfolio

Every portfolio needs to have at least one mature company that generates a lot of cash flow and returns capital to shareholders in a generous manner. It's even better if that company is constantly finding ways to cut costs while also increasing its competitive advantages. One such company is Sysco (NYSE: SYY  ) . As you might already know, Sysco recently purchased US Foods for $3.5 billion. The deal has been approved by both boards, and it's expected to close in the third quarter of 2014 as long as it passes regulatory approval. Now let's take a look at what this deal means for Sysco, and how it should increase the company's competitive advantages.

Improvements necessary
Prior to the Sysco/US Foods deal announcement, Sysco had been searching for ways to cut costs and improve margins, primarily through automation and centralization. These moves were necessary given Sysco's consistent decline in profit margin:

SYY Profit Margin (TTM) Chart

SYY Profit Margin (TTM) data by YCharts

With this deal in place, it's likely that Sysco's margin will improve. For instance, the deal will allow Sysco to reduce its head count, since available employees will have overlapping skill-sets. Customers and suppliers will also be integrated. Also, divestitures of distribution facilities are highly likely.

At the moment, Sysco operates 190 distribution facilities and US Foods operates 80 distribution facilities. By combining these distribution facilities and only keeping the ones that make the most sense from a geographical standpoint, Sysco can reduce costs significantly. Sysco has stated that it will take several months for it to decide what to divest. Therefore, don't expect any news about this right away.

While all integration decisions haven't been made yet, Sysco expects estimated annual synergies of $600 million after three to four years. The company cites supply chain improvements, merchandising optimization, and overlapping general and administrative functions as catalysts.

Investing in Sysco is all about patience. For example, if you look at total shareholder return (stock appreciation plus dividend payments) over the past five years, you will see a methodical yet reliable ascent:

SYY Total Return Price Chart

SYY Total Return Price data by YCharts

Sysco currently yields 3.20%, and given that it generated $1.47 billion in operating cash flow over the past year, that healthy dividend yield shouldn't be going anywhere.

Top-line growth
When people hear (or read) the name Sysco, they don't often think about top-line growth. However, take a look at the company's top-line performance over the past five years:

SYY Revenue (TTM) Chart

SYY Revenue (TTM) data by YCharts

We're not talking about Amazon here, but any top-line growth in the current economic environment is a positive. Sysco generated $44.1 billion in revenue in 2012. US Foods generated $22 billion in revenue in 2012. Combining these two companies could form a monster that would have pricing power with vendors. The new combined company also has the potential to fight off rising distribution threats from Costco (NASDAQ: COST  ) and Wal-Mart (NYSE: WMT  ) thanks to increased scale. On top of that, Sysco and US Foods should complement each other well, as Sysco is more of an institutional business and US Foods is known as more of a street business.

Sysco potential
If this deal gains regulatory approval, then you're likely to see top-line growth, increased scale that should lead to competitive advantages, aggressive cost cutting that should reduce costs and improve margins, and possibly even increased capital returns to shareholders. I think Sysco would be a good long-term addition to any diversified portfolio. Even if the stock underperforms, generous dividend payments have the potential to make up for it. All that said, please do your own due diligence prior to investing. 

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  • Report this Comment On December 24, 2013, at 10:31 AM, phairphair wrote:

    "... Sysco and US Foods should complement each other well, as Sysco is more of an institutional business and US Foods is known as more of a street business."

    This is untrue. US Foods' portfolio is 60% with large GPOs such as Premier (the nation's largest), Novation and Avendra.

    Sysco has a proportionally greater share of street business than US Foods, although USF has been taking share over the past 2 years. No doubt one of the catalysts for the merger.

    On the investor call, one of the most commonly expressed concerns was regarding the very significant overlap in business. A large portion of street customers already buy from both Sysco and USF, so this will force them to add an additional distributor to their weekly orders, effectively reducing the combined company's market share.

    For both street and contract customers, having most or all of their business with the 'new' Sysco will represent an unacceptable risk.

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