Sysco Corporation Continues To Be A Good Stock To Hold

Aug.24.14 | About: SYSCO Corporation (SYY)

Summary

The consumer defensive sector has been experiencing headwinds.

Sysco’s top-line has gained momentum but needs to work on its margins.

Sysco is a good stock to hold.

Sysco Corporation (NYSE:SYY) is among those companies that have been considered as defensive investments for investors. Sysco has proved itself to be a defensive investment by making 45 successive dividend increases. It is operating in the consumer defensive sector and the sector has been experiencing slow growth over the past few years due to a number of reasons which include low purchasing power, pricing pressure, high costs, emergence of private labels and strong competition. As a result, the restaurant industry, the packaged food industry and the food distribution industry are experiencing slow growth in generating top and bottom line growths. The companies in the consumer defensive sector are making more moves to sustain growth. They are making acquisitions, launching new products and also searching for new markets to sustain their top line growth.

We can see the impact of headwinds on Sysco's financial performance and dividends. The company has been experiencing a slow growth in its top and bottom lines over the past few years. However, the company has gathered a new strategy to cope with the challenging business environment. Its strategy has started to work for the company because it has generated growth in sales over the past four quarters. The plan is to enhance people's experiences, improve productivity, and expand its product portfolio while capturing market shares in new markets. This strategy has recently worked for company and Sysco announced 2014's fiscal results with a 5.9% increase in sales. Furthermore, the company is making a merger with U.S Foods which will raise its sales to $65billion. After the merger, the remaining company will be named as Sysco.

Nevertheless, Sysco still finds difficulties in making growth in its earnings. This is particularly due to the higher direct and indirect costs. Due to the strong competition in the market and lower purchasing power, this food distribution company finds difficulties in increasing prices to balance the costs and earnings. At the end of the 2014 fiscal year, its operating income decreased by 4.3% as compared to the past year and the net income went down by 6.1%. This trend continues to be observed in the past three years' results. Since 2012, its earnings per share has come down from $1.90/share to $1.58/share in 2014. With a continuous decline in its earnings, its payout ratio based on earnings is also increasing thus creating hurdles for the company in making big increases to dividends. At the moment, the company is paying 70% of its income in dividends.

Amidst all this, its cash generating potential is still strong enough to support dividends and capital requirements because its free cash flows are providing cover to its dividends. At the end of the 2014 fiscal year, Sysco had generated $955 million in free cash flows which are higher than its dividend payments of $670 million. As a result, we can say that Sysco's dividends are completely safe. It has a very strong cash generating potential because its free cash flows are higher than its earnings. However, I am not expecting a significant increase in its forthcoming dividends due to the business environment it has found itself in and also due to its earnings trend. In the past five years, Sysco has increased its dividends by only 20.8%. However, it has increased dividends by over 103% from 2003 to 2008. This shows that it has been experiencing difficulties in making increases to its dividends due to the fall in earnings.

In Conclusion

Sysco's performance still looks attractive in front of headwinds. Its revenue base is growing and will grow substantially in the coming days with the merger to U.S Foods. However, the company still needs to work more on its margin. I think significant cost measures can take the company out of this situation. Its cash potential is strong so it is not facing any risk of solvency and the ability to lose dividends. Sysco will continue to be a defensive investment for investors.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.