Saturday, December 13, 2014

Why did I sell Sysco (SYY)

I don’t sell stocks often. You can see this for yourself – I have more fingers than Recent Sale articles published on this blog over the last 3½ years.
And that’s because I look at every stock as a fruit-bearing branch on my dividend tree. Every stock sale means I’m cutting a branch, which will reduce the amount of fruit my tree can possibly produce. However, if the occasional pruning makes the tree bigger and stronger, then it’s a chore I’ll willingly and dutifully perform.
I’m actually getting to the point to where I’m loathe to sell shares in businesses, even those that are underperforming. Temporary issues can cloud one’s vision of long-term operational expectations. Furthermore, I once read that a portfolio is like a bar of soap; the more you handle it, the less you’ll have in the end. I believe that’s true.
But this most recent transaction has been a long time coming. I’ve been waiting for operations in this particular business to improve, but hope has not magically turned into reality. This is a bit sad for me, as this is one of my oldest holdings. But it’s time for me to say adieu and bid the company the best of luck.
I sold 29 shares of Sysco Corporation (SYY) on 11/25/14 for $39.50 per share.


Sysco Corporation, through its subsidiaries and divisions, is a leading distributor of food and related products across North America. They also have operations in Ireland.
Sysco is the largest such distributor in North America, with an estimated 17%  market share. They distribute a wide variety of food and equipment products, including fresh and frozen meats, dairy products, fresh produce, canned and dry products, and poultry.
The company operates 194 distribution centers and serves approximately 425,000 customers.
62% of their fiscal year 2014 sales were generated via customers in the restaurant industry. No one customer accounted for more than 10% of FY 2014 sales.


The primary reason I sold Sysco is due to deteriorating fundamentals, which I’ll discuss below. Their fiscal year ends June 30.
Revenue grew from $30.282 billion in fiscal year 2005 to $46.517 billion at the end of FY 2014. That’s a compound annual growth rate of 4.89%. Certainly not the worst I’ve seen, and perhaps not all that unsurprising considering the mature and competitive market they operate in.
Earnings per share increased from $1.47 to $1.58 during this period, which is  a CAGR of 0.81%. Obviously, this is extremely disappointing.
S&P Capital IQ predicts EPS will grow at a compound annual rate of 9% over the next three years, anticipating improved purchasing power and cost synergies associated with an acquisition as I’ll discuss below.
You might be asking yourself why I would invest in a company with such poor growth in profit, but Sysco was actually growing at an attractive rate when I invested. I initially purchased my 29 shares on 10/7/2010 for $28.60 per share. Their earnings from fiscal years 2005 to 2010 looked like this: $1.47; $1.36; 1.60; 1.81; 1.77; 1.99. So there’s a clear uptrend here. Leading up to my purchase, the company was growing at a rather brisk rate. However, fiscal year 2011 started a downtrend in EPS, as you can see in the results from fiscal years 2011 to 2014: $1.96; 1.90; 1.67; 1.58.
The dividend growth has likewise slowed down, which is unsurprising considering the anemic growth in profit. The five-year dividend growth rate stands at 4.9%, and this rate is declining. For the last few years, the dividend raises have been a penny per share per quarter. The most recent increase that was announced on 11/19 amounted to 3.44%, and this announcement led to me considering selling my stake after years of disappointing results.
Now, one might take solace in the fact that the company has increased its dividend for the past 45 consecutive years, and you wouldn’t be wrong to consider that as a major positive aspect for this company.
The stock yields 3.03% here, which is attractive. But with a payout ratio of 76.9%, I can’t imagine dividend growth is going to increase anytime soon. So you’ll have to decide if a yield of 3% and dividend growth of ~3% suits your investment needs.
The company’s balance sheet is leveraged, but it seems appropriate to me. The long-term debt/equity ratio is 0.45, while the interest coverage ratio stands at 12.93. These are pretty attractive numbers.
Profitability metrics are rather disappointing. Net margin has averaged 2.6% over the last five years, and this number continues to move in the wrong direction year after year. The company cites an inability to pass along certain rises in input costs along to customers. Return on equity averaged 24.25% over this time frame. This also continues to decline annually. Both of these numbers were much healthier when I initially invested back in 2010.

Qualitative Aspects

So I mentioned an acquisition earlier. In December 2013, Sysco announced that it planned to acquire US Foods. US Foods is the second largest food distributor in the United States, so you’re looking at locking up the two largest players. This announcement kept me hanging on for a bit longer than I probably should have, though the announcement gave a nice price pop to shares that would have otherwise most likely not have materialized.
Now, this announcement offers benefits and drawbacks. At first, I was focusing on the benefits only. This seemed to be the savior for my otherwise poor investment. Locking up the two largest players will surely lead to cost synergies, greater economies of scale, increased purchasing power, and better clout across the industry. And I’m willing to bet these benefits will largely materialize, depending on what kind of demands are placed on the companies in regards to the acquisition. Potential asset sales are possible.
However, I wasn’t really looking at the negative aspects. Primarily, Sysco is valuing the deal at $8.2 billion. That’s a pretty significant acquisition for a company with a market cap of $23.5 billion, so there’s a chance that they’re biting off more than they can chew. In addition, there’s the equity they’ll have to issue for the acquisition – $3 billion worth of common stock. How that affects the dividend is anyone’s guess. And then there’s the debt, as Sysco will be assuming $4.7 billion worth of debt from US Foods. I’m sure they’ll refinance as much as they can, but that’s a hefty load for a company that currently sports $2.4 billion worth of long-term debt.
All in all, I just see a lot of potential issues here with this acquisition. And that’s not to mention that it’s been continually delayed as antitrust regulators continue to review all the details.
But Sysco by itself is still a solid business. They are the largest player in a market with plenty of expansion potential, though the market itself is quite mature. Morningstar recently reduced their economic moat from wide to narrow, citing their inability to pass along input cost increases, and this bears itself out in the margin compression. The good news is that this mature market leads to stability, and I find it highly likely that SYY will continue to pass along mediocre dividend raises for the foreseeable future. I just find the upside limited.
Overall, I view Sysco as highly competitive, but the industry they operate in is brutal. I believe I underestimated this when I initially invested in the company.


I view Sysco as a low-risk investment, overall. However, there are near-term risks, primarily with the proposed acquisition. Considerable debt will be assumed and there will also be dilution to current stockholders, if the acquisition is approved. One risk I see with the heart of the business is the fact that the majority of their sales are to the restaurant industry, and that remains a stressed and competitive industry itself.


SYY trades hands for a P/E ratio of 25.32 right now, which I find egregious considering their lack of growth over the last decade. Their P/E ratio was on par with Visa Inc. (V) (a high-growth stock) until Visa popped after the last earnings report. Sysco’s P/E ratio is obviously well above the broader market, while it’s also considerably higher than its own five-year P/E ratio average of 16.8. I believe part of that premium exists due to the acquisition. Any issues with the acquisition could substantially negatively affect the stock, in my view.
I valued shares using a dividend discount model analysis with a 10% discount rate and a 6% long-term growth rate. I was being liberal with that growth rate considering their results over the last 10 years. There is some uncertainty, however, due to the potential acquisition, so I’m attempting to model in some benefit of the doubt. The DDM analysis gives me a fair value of $31.80.


I’m a long-term investor. And I’ve been invested with Sysco for more than four years now. I gave them opportunity after opportunity to improve results, and just the opposite happened. I understand they’ve been restructuring and the restaurant industry has been brutal, but I feel my capital can do better elsewhere. When considering whether or not to sell, I asked myself if I would invest in Sysco today, and my answer was an unequivocal “no”.
My total cost basis was $836.40. My total proceeds were $1,138.48. I received a total of $127.60 in dividends over the last four years. That means my total return on SYY was 51.4%. This is much better than I would expect with the way operational results have panned out over the last four years, but I did better than I should have due to the expansion of the P/E ratio. Fine by me, and allowed me to get out with a solid return. However, this was still largely disappointing because there’s the opportunity cost of doing much better elsewhere. I consider this a poor investment on my part, but I still contend that I was looking at better numbers when I placed my bet. Just didn’t pan out as I expected, which happens. That’s why you diversify, and I never added to my SYY position because things started to move in the wrong direction.
As always, I’m going to include a couple of other valuation opinions below, as I use these to concentrate my reasonable valuation estimate:
Morningstar rates SYY as a 3/5 star value, with a fair value estimate of $42.00 (pro forma, factoring in the US Foods acquisition).
S&P Capital IQ rates SYY as a 2/5 star sell, with a fair value calculation of $34.80.
This sale reduces my annual dividend income by $34.80, based on the current quarterly $0.30 dividend.
I’ll update my Freedom Fund in early December to reflect this recent sale.
Full Disclosure: Long V
What are your thoughts? Do you like Sysco? Think I made a mistake? 
Thanks for reading.

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