Published by Bob Ciura on November 16th, 2017
The Dividend Aristocrats are a group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
This update will cover food distribution giant Sysco (SYY).
Sysco has a long history of steady dividends, and regular dividend increases. It has paid a dividend every quarter since it went public in 1970. Over those 47 years, it has increased the dividend 48 times.
Sysco stock is down 2% year-to-date, while the S&P 500 Index is up approximately 15% so far in 2017. Sysco shares have trailed the returns of the S&P 500 Index so far this year, by approximately 13 percentage points.
The stock still trades for a valuation above its 10-year average, meaning Sysco does not appear to be undervalued right now.
However, Sysco has many attractive qualities. It is the largest company in its industry, which provides it with high profit margins. It also has growth potential, and the ability to increase its dividend each year.
Business Overview
Sysco was founded in 1969, and went public the following year. In its first year as a publicly-traded company, it had sales of $115 million.
The company has grown steadily over the nearly five decades since. Last year, Sysco had sales of more than $55 billion.
Today, Sysco is the largest food distributor in the U.S. It distributes products including fresh and frozen foods, as well as dairy and beverage products. It also provides non-food products including tableware, cookware, restaurant and kitchen supplies, and cleaning supplies.
Source: Barclays Consumer Staples Conference, page 5
The company has a wide range of customers, which include:
- Restaurants (61% of sales)
- Healthcare (9% of sales)
- Education/Government (9% of sales)
- Travel/Leisure/Retail (9% of sales)
- Other (12% of sales)
The ‘other’ category includes bakeries, churches, civic and fraternal organizations, vending distributors, and international exports.
In all, Sysco has approximately 500,000 customers. Its position atop the food distribution provides Sysco with high profit margins, and future growth potential.
Growth Prospects
The operate climate for Sysco is challenged in the U.S., due to the “restaurant recession”. Restaurant traffic has declined over the past year, driven by several factors, including eroding mall traffic, and low grocery prices.
Since restaurants are Sysco’s largest customer group by far, this has presented a difficult fundamental backdrop in the U.S. For example, for fiscal 2017, U.S. sales declined by 0.5%. On a comparable 52-week basis, U.S. sales increased 1.5% for the year.
The good news is, Sysco continues to cut costs in its U.S. business. U.S. segment gross margin expanded by 48 basis points last quarter.
Plus, Sysco still reported strong overall growth rates last year. Total sales increased 10% last year, driven in large part by the $3.1 billion acquisition of Brakes Group.
Source: Barclays Consumer Staples Conference, page 11
Brakes is one of the largest foodservice companies in Europe. It serves fresh, refrigerated, and frozen foods to over 50,000 customers, and has a leading presence in the U.K., France, Sweden, Ireland, Belgium, Spain, and Luxembourg.
International growth is a major catalyst for Sysco moving forward. International segment sales nearly doubled last year.
In the fiscal 2018 first quarter, Sysco grew total sales by 4.9%. Adjusted earnings-per-share increased 10% last quarter. Sales increased 3.9% in the U.S., and 6.4% in Sysco’s international markets.
Competitive Advantages & Recession Performance
The U.S. foodservice industry is highly competitive. There are thousands of competitors to Sysco, which include other food distributors, as well as wholesale or retail outlets, grocery stores, and online retailers. Sysco also faces the risk of its customers negotiating directly with its suppliers.
However, what has kept competitors at bay for so many years, is that Sysco is the largest operator in the industry. It controls about 16% of the $280 billion U.S. foodservice industry. Sysco operates 300 distribution facilities. Such a huge presence allows Sysco to keep costs low, which it can pass on to its customers.
Another benefit of Sysco’s business model is that it is resistant to recessions. Everyone has to eat, which gives Sysco a certain level of demand, regardless of the condition of the U.S. economy.
This is why Sysco’s profits held up well during the Great Recession:
- 2007 earnings-per-share of $1.60
- 2008 earnings-per-share of $1.81 (13% increase)
- 2009 earnings-per-share of $1.77 (2% decline)
- 2010 earnings-per-share of $1.99 (12% increase)
Sysco grew earnings-per-share at a double-digit pace in 2008 and 2010, with only a mild dip in 2009. The company grew earnings from 2007 to 2010, which was a rare achievement.
Sysco’s stable industry and top competitive position, allowed it to raise its dividend each year, even during recessions.
Valuation & Expected Returns
Sysco generated adjusted earnings-per-share of $2.48 per share in fiscal 2017. Based on this, the stock has a price-to-earnings ratio of 21.9.
By comparison, the stock has an average price-to-earnings ratio of 17.9 over the past 10 years. This indicates the stock is fairly valued right now.
Source: Value Line
That said, Sysco can still generate positive shareholder returns, through earnings growth and dividends. In the past 10 years, Sysco grew earnings-per-share by 3% compounded annually.
The global economy continues to grow, and Sysco has enhanced growth potential through acquisitions and cost cuts. As a result, Sysco’s earnings growth could come in slightly above its 10-year average growth rate.
A potential breakdown of future returns is below:
- 3%-5% revenue growth
- 1% margin expansion
- 2% share repurchases
- 5% dividend yield
Based on this, Sysco would generate total returns of 8%-11% per year.
Sysco should have little trouble increasing its dividend. The company had a free cash flow payout ratio of less than 50% in fiscal 2017. This indicates the dividend is more than sufficiently covered by free cash flow, with room for future dividend increases.
Final Thoughts
Sysco operates at the top of a stable industry. It is highly profitable, and should see steady demand, even during recessions. These qualities make Sysco a reliable stock for annual dividend increases.
The stock is not significantly undervalued, but can still generate returns through earnings growth and dividends. As a result, Sysco remains a quality holding within a dividend growth portfolio.
