Food for Thought at Sysco

Food distributor Sysco (NYSE:SYY) reported first-quarter earnings yesterday, and while this stock is on a number of Foolish watch lists, at its current levels it may be best suited to stay on the bench.

For the quarter, sales advanced 8.3% to $8.7 billion, while operating earnings jumped 14.8% and diluted earnings grew 19.4%. Both figures excluded the effects of a couple of accounting changes; earnings fell almost 10% when the charges were included. Top-line growth was slightly above the 6% posted last quarter, and it's been in the high single digits for the past few quarters now. However, bottom-line trends have been more difficult to discern, because of numerous accounting changes and charges for stock option expenses.

Sysco is no longer growing as quickly as it once did. While total sales growth has held up in the neighborhood of 8% each year over the past five years, investors used to be able to count on at least 10% top-line growth. And earnings and operating cash flow trends have also been uneven. Over the past five years, net income has grown 7.5% annually, while operating cash flow has advanced only 3.3%. Both have actually shrunk 2.9% on average over the past two years.

So why the lofty earnings multiple? As far as I can tell, investors are giving Sysco the benefit of the doubt because of its stellar historical track record. It's also still the largest food-service company out there, posting subsequent impressive profitability, because it's able to spread high fixed costs over a very wide customer base and across its sales and distribution network.

To illustrate, over the past 12 months, Sysco has posted a 2.5% net margin, versus 1.8% at United Natural Foods (NASDAQ:UNFI) and 0.8% at Performance Food Group (NASDAQ:PFGC). That's impressive in the industry, but net margins for the S&P 500 in general average closer to 13.7%. Unfortunately, the food-service industry is very capital-intensive -- annual capex needs have been eating up about half of operating cash flow at Sysco, because of the need to build new distribution centers and purchase competitors to supplement flagging organic growth.

In any case, Sysco has had an impressive run since its inception, growing sales from $115 million in 1970 to $32 billion as of the end of the most recent fiscal year. And while the company should be able to keep growing sales at close to 10% each year, the bottom line will be lucky to reach that level, based on more recent trends. At 22 times this fiscal year's projected earnings, the recent stock price of $35.10 is too rich for my blood, even considering the nearly 2% dividend yield.

I was tempted when the stock fell below $30 back in late July, but I'd probably only be interested if Sysco fell to the low $20 range. I'm drawn to the company on account of its industry leadership and dominance in serving nearly 400,000 customers, including the largest restaurant chains, such as Wendy's (NYSE:WEN) and Burger King (NYSE:BKC). But at this point in time, I don't believe it's capable of growing in the double digits, which it must do to justify the current multiple attached to the share price. Overall, investors may be paying for past performance, as the future will probably not turn out so rosy.

For related Foolishness:

• Summarizing Sysco: Fool by Numbers
• Dueling Fools: SYSCO Bull
• Will SYSCO Sink or Swim?
• Might SYSCO Be Worth a Nibble?
• SYSCO: I Still Don't Get It

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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. The Fool has an ironclad disclosure policy. Feel free to email him with feedback or to discuss any companies mentioned further.