The general economic environment and consumer confidence can influence the rate of purchases and amounts spent by consumers for food away from home and, consequently, can impact the number of consumers and amount of sales of food distribution businesses. People continue to spend their disposable incomes in a more and more disciplined way, which has added to a slow rate of improvement in the foodservice market of late. Though these trends are cyclical in nature, better consumer confidence is required to overturn the trend. Based on industry sources, actual sales growth for the foodservice business in the U.S. is anticipated to be modest over the long-run. These industry trends emphasize the need for food distributors to transform their businesses to decrease overall costs and supply greater value to their customers.
Looking at the economic environment and consumer's sentiments, Sysco Corporation (SYY), a leading food distributor to healthcare and educational facilities, restaurants, lodging establishments and other foodservice customers, revised its business strategy and has been looking to transform its business operations. The company has a diversified business model with operations in United States, Canada, the Bahamas, the Republic of Ireland and Northern Ireland.
Sysco is focused on optimizing its core broad line business in the U.S., Canada, the Bahamas, the Republic of Ireland and Northern Ireland, meanwhile continuing to explore suitable opportunities to profitably grow its market share and to create value for share holders by expanding beyond its core business. To do this, the company has identified five strategies to help it achieve its goals:
- Profoundly improve the experience of doing business with Sysco.
- Continuously enhance productivity in all aspects of its business.
- Expand its portfolio by initiating a customer-centric innovation program.
- Search for and assess new businesses and markets.
- Develop and effectively integrate a comprehensive, enterprise-wide talent management process.
With these strategies, Sysco is looking to drive sustainable, profitable growth, increase operating margins and free cash flow, and increase asset optimization. In order achieve its objectives, in Q2 of the fiscal year 2014, Sysco made an agreement to merge with US Foods which is a leading foodservice distributor in the United States. US Foods distributes fresh, frozen, and dry foods to about 200,000 foodservice customers including local and national chain restaurants, privately owned restaurants, hotels and motels, government organizations, and retail locations. After the proposed merger, the company will retain the name of Sysco and is expected to have annual sales of about $65 billion.
Further, Sysco is looking to transform its business in order to enhance operational efficiencies and reduce its cost structure so that it can generate profitable growth in the tough economic environment. Sysco's multi-year Business Transformation Project consists of three initiatives. The first is to support a majority of its business processes and further streamline its operations. The second is to create initiatives to lower its operating costs and the third is to include efforts to increase its productivity in the warehouse and delivery activities, including maintenance and fleet management activities. This also involves increasing sales productivity and dropping general and administrative expenses, partially through aligning pay rates and benefit plans. Finally, the business transformation project is focused on a category management initiative to use customer insights and market data to adjust product pricing and enhance product assortment to drive sales growth.
Recently, Sysco announced second quarter results with a top line standing at 11.2 billion, representing an increase of 4.1% over the last year. Its recent acquisition added to sales by 1.9%. Case volume for its SYGMA and broad line operations, combined, has increased by 4.3% during the quarter. The company has also been making solid growth in its top line with the help of acquisitions. The bottom line, however, is not growing at same pace. The company has been facing challenges in converting higher sales into better profits. With a 4% growth in top line, the company has generated negative bottom line growth at 4.8% due to the higher operational costs.
Amid all this, Sysco's cash flow generating potential has not been impacted with the decrease in its earnings. During the first half of 2014, its operating cash flows increased by 18.5% to $458 million, and capital expenditures were at $270 million for the first half of the year. The primary areas for investment included expansions and facility replacements, and replacements to Sysco's fleet. Sysco's strategic objectives include investment in its business funded from both cash from operations and access to capital from financial markets. Its operational cash flows are providing adequate cover dividend payments, which makes its dividends completely safe. Recently, the company has demonstrated this trend again by a paying regular quarterly dividend of $0.29/share. Sysco's payout ratio of around 68% is also at a manageable level.
I see expense management measurements, new strategies, debt management, and business transformation to attain higher operational efficiencies as key steps towards Sysco's future performance. On top, its proposed merger with US Foods can take the company to new heights if the combined company quickly reduces its operational inefficiencies and succeeds in enhancing margins. I see no problems for Sysco in sustaining its ability to generate significant cash flows and I believe it is also capable of raising capital from the market when needed.