Sysco Gets Dealt a Major Blow: What It Means for Investors

Growth in the food distribution industry is slowing. The U.S. market is saturated with competition, and American consumers are displaying an undeniable shift in buying preferences -- away from pre-packaged food and toward fresher alternatives like organics. All of this is bad news for Sysco Corporation (SYY -0.25%), which has turned to merger and acquisition activity in light of the slowing growth in its industry.

M&A can help companies buy growth when organic growth in their core businesses slows down. Sysco found a prized target when it struck a deal to buy US Foods in a large, $3.5 billion takeover.

Unfortunately, Sysco was dealt a brutal blow when the Federal Trade Commission revealed its opposition to the deal earlier this year. Rather than go ahead with the planned acquisition and risk a lengthy and costly legal battle, Sysco has simply scrapped its intention to buy US Foods.

Here's why Sysco investors should take notice.

Few growth opportunities around
As previously mentioned, the food distribution business in the U.S. is rife with competition. In fact, Sysco calculated in its last 10-K filing that there are more than 15,000 companies engaged in the distribution of food and non-food products to the food service industry in the United States.

Furthermore, consumers are opting for organics at an accelerating pace. According to a 2013 study by market research company TechSci Research, the U.S. organic food industry is set to grow at a 14% compound annual clip through 2018. Large food companies must adapt to this reality.

This has all had a real effect on Sysco's top and bottom line. Fiscal 2014 sales grew 4%, but diluted earnings per share fell 5% year over year. As you can see from the following table, Sysco has been stuck in a prolonged, multi-year profit slump.

For Sysco's profit to be lower last year than it was during the depths of the Great Recession is a major concern. No doubt this was the impetus for the US Foods takeover bid. Plus, Sysco is off to an equally unimpressive start to 2015. Over the first three quarters of the company's current fiscal year, diluted EPS has declined 10% from the same period a year ago.

This is why the acquisition of US Foods was crucial for Sysco. M&A is perhaps the best avenue to produce meaningful earnings growth for the company, as Sysco would have reaped significant synergies once the deal was completed by eliminating duplicated costs. Now, Sysco doesn't seem to have many options to significantly grow earnings going forward. Adding insult to injury is that Sysco will have to pay a $300 million break-up fee to US Foods now that the merger has failed.

With the merger off the table, Sysco authorized a $3 billion share buyback. This will help Sysco boost earnings per share growth going forward, but the stock is valued fairly aggressively. At 24 times EPS, Sysco isn't getting a lot of bang for the buck on its planned buybacks going forward, which will limit the amount of EPS growth it can derive from this tactic.

Count on the dividend, and not much else
Sysco is a well-known and highly regarded stock among income investors because of its long history of paying dividends like clockwork. Indeed, Sysco has paid a cash dividend since its incorporation as a public company in 1970 and has increased its dividend 46 times during that period. Sysco offers a solid 3.3% dividend, which is protected with sufficient cash flow.

But that 3.3% dividend is about all investors can count on. Sysco is having a very hard time growing the bottom line, and as a result, its dividend growth is grinding to a halt. Looking back at Sysco's recent dividend history, the company only managed to increase its quarterly payout by $0.01 per share for the last six dividend raises. In the past five years, Sysco has increased its dividend by just 3% per year, which barely beats inflation.

For investors simply looking for a 3% dividend, Sysco is still a viable option. But investors looking for growth should look elsewhere.