Yagi Studio
With many economists and financial experts forecasting a recession in 2023, we are taking a look at resilient dividend growth companies that could perform relatively well even during tough economic times. The obvious choice is to go with consumer staples stocks (XLP), but unfortunately their valuations are quite rich at the moment. One company that could perform well during a mild recession is Sysco (NYSE:SYY). It has outperformed the S&P 500 index (SPY) for a long time, and notably it outperformed the market around the 2001 recession very meaningfully. It under-performed during the Covid recession, but that is far from surprising given that many of its customers were closed during that period.
As a reminder, Sysco is a leading global foodservice distribution company, providing products and services to restaurants, healthcare and educational facilities, hotels, and other customers who prepare meals away from home. Sysco has strong competitive advantages due to its massive scale, which allows it to negotiate favorable terms with suppliers and pass on savings to its customers.
At the moment the valuation is reasonable but we consider the company only a weak ‘Buy’, because we believe there are other much more attractive opportunities currently in the market. In any case, it is a company that is performing well, has proven resilient in the past, and is certainly worth having on the watch list in case an opportunity presents itself to buy shares at bargain prices, as happened during the Covid pandemic.
Sysco has been gaining market share coming out of the Covid crisis, with its growth in Q1 exceeding the market by a factor of 1.4x. In Q1 FY23 Sales were ~$19.1 billion, gross profit was ~$3.5billion, and adjusted EPS was $0.97, roughly 16.9% higher than last year. Sysco also reaffirmed its fiscal year 2023 guidance of an adjusted EPS of between $4.09 and $4.39.
Competitive Moat
One of Sysco’s key competitive advantages is its vast distribution network. The company operates thousands of trucks and has a network of hundreds of distribution facilities, which enables it to efficiently serve a diverse customer base.
This scale allows Sysco to offer a wide range of products at very competitive prices, and provide reliable and timely delivery to its customers.
Financials
This competitive moat is reflected in the financials. We can see that the company’s profit margins are significantly higher than those of competitor US Foods (USFD).
The company’s return on capital employed has now recovered after a sharp drop following the Covid crisis, and is once again above the ten year average. A ROCE of ~17% is reflective of a high-quality company with competitive advantages, and once again, it is significantly higher than that of US Foods, one of its main competitors.
Balance Sheet
While Sysco has significant debt, its long-term debt is well spread through fiscal 2052, so we are not too concerned about refinancing risks at this time. The company also has a long-term revolving credit facility that includes aggregate commitments of the lenders of $3.0 billion, with an option to increase such commitments to $4.0 billion. As of October 1, 2022 there were no borrowings outstanding under that facility. Sysco also has ~$437 million in cash and short-term investments.
The financial leverage is a bit higher than what we would like to see, with financial debt to EBITDA of ~3.2x. Sysco is planning to improve its leverage situation, targeting a net debt to EBITDA ratio of 2.50x to 2.75x.
Dividend Growth
One of the big attractions for investors is that the company is generous with its shareholder returns. For example, it returned $517 million to shareholders in the last quarter through dividends and share repurchases. Sysco has an impressive record of dividend increases spanning decades.
In the last five years, the quarterly dividend has gone from $0.36 per share, to $0.49 per share, representing a compounded annual growth rate of ~6.3%.
The payout ratio has been decreasing recently, so we would not be surprised if the company makes the next dividend increase meaningful.
Valuation
We believe the company deserves a premium valuation due to its competitive advantages, and we therefore believe an EV/EBITDA multiple of ~15x to be reasonable, although far from a bargain. Seeking Alpha’s ‘C-‘ valuation grade appears appropriate.
Seeking Alpha
The ten year average EV/EBITDA multiple is ~15.8x, very close to the current multiple, but shares were much cheaper ten years ago trading at only a ~10x multiple.
The price/earnings ratio tells a similar story, with the current multiple somewhat below the ten year average. We would point out, however, that the period where the p/e ratio went to triple digits was because earnings collapsed during the Covid crisis.
The net common payout yield, which combines the dividend yield and the buyback yield, is currently ~4.4%. We consider this to be more important than the dividend yield by itself, since it is more reflective of the total amount being returned to shareholders. The dividend yield by itself is close to 2.4%.
Our preferred approach to calculate fair value is to estimate the net present value of the future earnings stream. Below we share our calculation, which results in an estimated fair value of ~$86 per share. The share price currently being a little bit lower, there is some margin of safety, but not as much as we like to see before buying.
| EPS | Discounted @ 10% | |
| FY 23E | 4.15 | 3.77 |
| FY 24E | 4.74 | 3.43 |
| FY 25E | 5.26 | 3.56 |
| FY 26E | 5.73 | 3.59 |
| FY 27E | 6.25 | 3.56 |
| FY 28E | 6.81 | 3.53 |
| FY 29E | 7.42 | 3.50 |
| FY 30E | 8.09 | 3.46 |
| FY 31E | 8.82 | 3.43 |
| FY 32E | 9.62 | 3.40 |
| FY 33E | 10.48 | 3.37 |
| Terminal Value @ 3% terminal growth | 149.73 | 47.71 |
| NPV | $86.31 |
Risks
During tough economic times consumers may reduce their spending on dining out, which could lead to a decline in demand for Sysco’s products and services. Additionally, Sysco’s business is subject to fluctuations in commodity prices, which can impact the company’s profitability. Another risk is the impact of competition on Sysco’s business, since the foodservice distribution industry is highly competitive, and Sysco faces competition from both large national players and smaller regional companies. Sysco also has a significant amount of debt, which it uses to fund growth initiatives.
Conclusion
Sysco is a high-quality company with strong competitive advantages due to its scale, reputation, diversified product mix, and financial strength. The company has an impressive history of outperforming the market, and of rewarding shareholders with increasing dividends and generous share buybacks. At current prices we believe shares to be a weak ‘Buy’, since shares are trading only moderately below our estimated fair value, and we also believe there are far more attractive opportunities currently in the market.
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