Sysco: Solid Results, but Shares a Bit Rich

Amid an environment of tepid restaurant traffic, we think

A portion of the margin improvement resulted from efforts to extract costs, as it targets a $500 million lift in operating income by fiscal 2018. And we contend Sysco’s recent initiatives still have legs, with our forecast calling for more than $700 million of savings by fiscal 2019 (just more than 1% of cost of goods sold and operating expenses), 70% of which we forecast will drop to the bottom line, resulting in 60 basis points of selling, general, and administrative leverage to 6.5% of sales by fiscal 2025. Combined with our forecast for a slight uptick in gross margins, we expect operating margins to edge up to around 5% over the next 10 years--about 100 basis points above fiscal 2016.

Following recent results, we’ll likely bump up our $43 fair value by a few dollars to account for its progress in driving efficiencies and the benefit from the time value of money. We still maintain Sysco has amassed a narrow moat, resulting from its vast distribution scale (with sales more than 2 times its next-largest competitor), which enables Sysco to leverage the high level of fixed costs that plague the industry. Shares trade north of our valuation, and we think investors should remain on the sidelines.

Despite tough industry dynamics, Sysco also generated decent case volume growth of more than 2%. However, food cost deflation (particularly for seafood, meat, and dairy) has yet to abate, amounting to around 1%. Management has previously attested that 2%-3% food cost inflation is an ideal operating environment for both itself and its customers, but we think its ability to withstand recent pressures suggests it has a better grasp on its cost structure now than in the past.

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