Sysco Corporation (NYSE:SYY), is a large distributor of food and related products. The most significant news in regard to the company over the past year is the mid-2015 termination of its merger agreement with U.S. Foods, days after the U.S. District Court in Washington, D.C., granted the U.S. Federal Trade Commission's request for a preliminary injunction to block the proposed SYY and U.S. Foods merger. At the same time, the company also terminated an agreement with Performance Food Group ("PFG") to purchase US Foods facilities in 11 markets. Under the terms of SYY's merger agreement, the termination of the transaction required SYY to pay break-up fees of $300 million to U.S. Foods and $12.5 million to PFG. The company decided against appealing the district court's decision blocking a merger with U.S. Foods and concluded that it was in the best interests of shareholders to move forward without trying to close the merger.
With the U.S. Foods merger now in SYY's rear-view mirror, the company intends to drive earnings through commercial and supply chain initiatives, including category management and revenue management in its core business, as well as pursuing cost-saving opportunities. In reviewing and transforming most aspects of its business, SYY has removed or avoided more than $750 million in annual product and operating costs. In addition, the company continues to generate strong and stable cash flow while also seeking to increase its free cash flow over time. In announcing the termination of the U.S. Food merger agreement, SYY also restated its commitment to increasing its dividend and its continued effort to seek out strategic acquisitions that would enhance shareholder value over time.
With the U.S. Foods merger falling through, SYY authorized an additional $3 billion to buyback shares (about 13 percent of current outstanding shares at the share price at the time of the announcement) over the two years following the announcement. Such share repurchases are being funded with new debt and cash flow from operations. The company acknowledged that they were comfortable with leveraging its balance sheet to enhance shareholder returns, but reiterated its commitment to maintaining investment-grade credit rating and a strong balance sheet. Further, the company acknowledged the possibility that its credit rating would be downgraded as a result of this new share repurchase program. SYY expects its share buyback to reduce its outstanding share count by about 4 percent to 5 percent and add about 3 cents to 4 cents per share to earnings per share in fiscal 2016. The company also projects a forward five-year dividend growth rate of 3 percent to 5 percent with a targeted dividend payout of 40 percent to 50 percent of net earnings.
SYY will continue to drive sales growth through acquisitions and increased volume. In September 2015, for example, Guest Supply, a wholly owned subsidiary of SYY, announced it acquired Gilchrist & Soames, one of the leading luxury personal care amenity providers in the hospitality industry with annual sales of approximately $60 million. With the company's acquisition of Gilchrist & Soames, it expects to continue to expand its personal care offerings for hotels, resorts and spas. While the company also plans to cut its operating costs by 2018, it continues to anticipate adverse currency effects and pressured gross margins to continue to negatively effect results. A weak recovery rate of recovery in the foodservice market has caused competitive pricing pressures for its products, which negatively impacts gross profits. Inflation also adversely affects SYY's gross margins. High food costs can also restrain consumer spending in the food-away-from-home market, thereby negatively affecting sales and gross profit. While the company faces an adverse macroeconomic environment, its growth strategy focuses on accelerating sales, reducing costs and minimizing pressures on gross margin.
With SYY's continued efforts to improve its revenue and profit growth through its internal growth strategy and acquisitions, potential investors should consider establishing a long-term position in the shares. We believe that all investors should include in their portfolio of stocks companies such as SYY. With extreme volatility returning to the overall market, investors may be surprised to find that SYY shares trade in a more stable manner than the overall market. Although SYY participates in a rather unglamorous industry, investors should consider investing in the company's shares to collect a 3.15 percent dividend along with modest share price growth. SYY may be a "boring" stock to own, but when market turmoil increases investors will be grateful to own it.
Fiscal first quarter 2016 earnings
In early November 2015, SYY announced adjusted earnings of 52 cents per share, equal to the year-ago quarter. Marginal growth in sales and improved gross margins were offset by a decline in adjusted operating income. SYY's sales were $12.563 billion, a 0.9 percent increase from the year-quarter due to volume growth being offset by adverse currency effects. Gross margins improved due to the company's ongoing growth strategy, which focuses on accelerating sales, reducing costs and mitigating ongoing gross margin pressures. Adjusted operating income decreased 0.5 percent to $506 million due to a 3.1 percent increase in adjusted operating expenses. Food cost deflation was 0.2 percent as the company experienced deflation in the dairy, meat, poultry and seafood categories, partially offset by modest inflation in other categories.
SYY has been able to record higher gross margins in its two most recent earnings reports. Such improvement occurred after the company experienced decreasing gross margins in the prior two fiscal years. Given such improvement, SYY's growth strategy appears to be showing positive results from its efforts to increase sales and margins. The company's sales have also consistently improved driven by acquisitions and volume growth. The company, however, continues to expect its earnings to remain under pressure due to adverse currency effects. In addition, SYY shares could perform better than expected if the company experiences a significant improvement in restaurant industry demand and lower-than-expected food inflation. Further, significantly lower gas prices are likely to increase SYY's profits given the company's use of a large fleet of trucks to deliver its products. Finally, as noted above, the company will continue to expand its personal care offerings for hotels, resorts and spas.
SYY's forward price-to-earnings ratio is about 21.10 based on 2016 earnings estimates of $1.93, and 19.20 based on 2017 earnings estimates of $2.12. Earnings estimates have been reduced slightly over the last 3 months for 2016 and 2017. We believe that potential investors should wait for the share price of SYY shares to drop to the $35.00 to $37.00 price range before establishing a full position (a forward price-to-earnings ratio in the range of about 16.5 to about 17.5, based on 2017 price-to-earnings estimates). The company is likely to continue to dominate its industry in the future as no other company has the resources to compete with SYY (such as warehouses and trucks). Lower profit margins in the foodservice industry will also discourage potential competitors from attempting to compete against SYY. For investors not afraid to own a "boring" stock, SYY will continue to reward investors with a 3.15 percent dividend, modest dividend increases, share buybacks and share price appreciation over the long term.
Disclosure: I am/we are long SYY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.