A bearish stance on food distributor SYSCO (NYSE:SYY) may seem hypocritical after my glowing article on the company's impressive fiscal 2007 results. The company also pays a nice 2.3% dividend yield, it's an industry leader, and it's been posting higher profit margins and earnings growth over the past few quarters. But despite all those pesky positives, I'm still hard- pressed to justify anteing up for shares of SYSCO.
SYSCO, grow? No go!
Sure, top-line and profitability trends are improving, but the company still has a track record of waning growth, a fact even management bemoans. It still aims for 7%-9% annual sales improvements and low- to mid-double digit earnings growth, but I'll contend that reaching these targets will only become more of an uphill battle as time passes.
Just look at the expansion trends in recent years. Since it commenced operations in 1970, SYSCO states, it has "grown from $115 million to over $35 billion in annual sales," as of the latest fiscal year. This has come from both organic growth and the active acquisition of 141 competitors over the last three-and-a-half decades.
I'll be the first to call this growth impressive, but trends over the last five years demonstrate that SYSCO has matured, especially now that it dominates the industry. Since 2002, the top line has expanded at only 8.5% annually, while earnings have risen 8% and cash flow from operations only about 5% over this time frame. Growth has slowed even more over the past couple of years, making me suspect that the most recent year marks a permanent end to SYSCO's heyday of rapid expansion. And years of industry consolidation mean there are few remaining peers to purchase, and even fewer that can have a meaningful effect on the bottom line.
Additionally, distributing food is a low-margin, capital-intensive business. Food and related products sell for only slightly more than they cost. Meanwhile, "to maximize productivity and customer service," SYSCO must spend to keep its distribution facilities modern and efficient. It must also maintain a large fleet of trucks and other vehicles to get orders to thousands of restaurants, hospitals, and other clients within 24 hours.
SYSCO's 2.9% net profit margin towers over those of easily bested rivals United Natural Foods (NASDAQ:UNFI), at 1.8%, and Performance Food Group (NASDAQ:PFGC), at 0.75%. Its adeptness at maintaining high turnover keeps returns on invested capital in the double digits. But the company realizes that low margins make it susceptible to current food-price inflation, as ethanol siphons demand for corn and other food that can also be used for fuel. Throw in higher gas prices, which make transporting orders more expensive, and SYSCO's margin expansion could soon end.
I fully concede that SYSCO is currently bucking inflation trends better than other food-related firms such as Kraft (NYSE:KFT), Sara Lee (NYSE:SLE), and Del Monte (NYSE:DLM). Projected double-digit earnings growth is also nothing to sneeze at, but at 57 times trailing free cash flow, SYSCO doesn't quite make a compelling investment opportunity for me.
Investing Foolishly includes identifying companies with leading brands and business models that lend themselves to mass markets and products with repeat purchase potential. SYSCO does dominate its industry, and food is definitely a vital product to all consumers. It also has strong historical performance, but I don't think the future will be as bright as SYSCO's past. Throw in high levels of capex to maintain the business, and I don't believe the stock is a long-term buy-and-hold -- despite the favorable near-term developments.
