I covered the Sysco Corporation (SYY) zero times – and that’s a problem because I didn’t buy it when it was even cheaper than it is today. The business has gone from $85 to nearly $35 during the pandemic — albeit briefly — because it’s one of the largest restaurant businesses in the world. It caters to restaurants, hospitals, schools, and the like and generates a ton of value in doing so. In an environment where growth-crushing pandemics are not common, we are dealing with a company that continues to be in an excellent position to generate strong dividend growth and capital gains. Plus, the balance sheet is repairing at a rapid pace and free cash flow implies a ton of value for investors. In this article, I want to share my thoughts and walk you through my thought process.
So bear with me!
This pandemic recovery is impressive
Sysco has a market capitalization of $39.9 billion, making it one of the largest companies in the grocery retail industry, which is part of the consumer defensive sector.
Sysco Corporation is an American multinational corporation involved in the marketing and distribution of food products, small items, kitchen equipment and tableware for restaurants, healthcare and educational establishments, hospitality businesses such as hotels and inns, and wholesale to other companies that provide food service (such as Aramark and Sodexo). The company is headquartered in the Energy Corridor neighborhood of Houston, Texas, where it was founded in 1969.
The company generated 66% of its sales from restaurants, followed by a well-diversified mix of healthcare, schools, travel and others. In case the caption is hard to read, the company operates in the light blue countries on the map below. Dark blue color indicates no business. Green color indicates “International Food Group”. According to business:
As the specialized export division of Sysco, IFG offers its expertise in product selection, services and value chain capabilities to customers in more than 80 countries around the world. Every day, US-based restaurant chains, ranging from fine dining to quick service, trust Sysco IFG to help them deliver their brand and unique customer experience around the world. With over 700 customers, we also export Sysco product brands to numerous distributors in many of the countries in which we do business.
In the United States, the company has a 17% market share in a highly fragmented $300 billion industry. The company increased its market share by 100 basis points over 2020. The company serves less than 50% of independent restaurants in the United States, which I think is already an incredibly high number, but management affirms that market penetration is one of the means to achieve strong growth in the short and long term. I agree with this as it has an edge over a lot of smaller companies in the industry.
The company has outstanding online features that make it easy for customers to order. Additionally, the company is implementing an omnichannel inventory system and distribution order management system to expand its supply chain. Especially nowadays, a great relationship with sellers is a pro.
This includes the company’s sales force, which focuses on consultative selling rather than managing administrative tasks, which makes selling highly effective.
As a result, the company says it has recovered 1.2 to 1.5 times faster than its industry from the pandemic. Excluding dividends, the company hit a new all-time high in the first half of 2021 after falling more than 60% during the pandemic when more or less everything was shut down. Restaurants, schools, hotels, everything was closed except nursing homes and the like, for obvious reasons. So a company as strong as SYY sold itself like a bank, which is truly remarkable.
That said, the company’s EBITDA is expected to surpass pre-pandemic levels in the year ending June 30, 2023, at more than $4.0 billion. That year, Sysco is expected to increase its free cash flow to $2.1 billion. This implies a free cash flow yield of 5.3% using a market capitalization of $40 billion. Remember that free cash flow is net income adjusted for non-cash items and capital expenditures. It’s basically money the company can spend on buyouts, dividends, debt reduction and the like.
The free cash flow yield could reach 6.3% in fiscal year 2024. Historically speaking, this is a bargain as the FCF yield has exceeded 6% only twice in its history – the one of them was during the Great Financial Crisis, which did a number on SYY stock price.
Between 2016 and 2024E, EBITDA is expected to grow by 5.8% per year. Free cash flow is expected to increase by 6.7%, proving the steps taken by the company to improve efficiency.
So what does this mean for shareholders?
Over the past 10 years, Sysco investors have enjoyed 242% capital gains and dividends (total return). This is about 20 points lower than the performance of the S&P 500 and the result of the pandemic which disrupted a significant outperformance. Over the last 5 years, the underperformance is also 20 points.
I not only believe SYY will outperform going forward, but I also like that Sysco is giving us a dividend yield premium of 105 basis points over the 1.4% yield of the S&P 500.
SYY is yielding 2.4%, the result of accelerating dividend growth since 2017.
The most recent dividend increase was announced on May 24, 2021. At the time, the increase was 4.4%. Seeking Alpha rates dividend consistency at A+ and shows that dividend growth has been 5.9% per year over the past 10 years.
This dividend growth rate is not high and explains why the dividend yield has fallen from 3.5% ten years ago to 2.4% currently. Capital gains outperformed dividend growth. I expect the yield to continue to hover between 2.0% and 2.4% with annual dividend growth between 5 and 10%.
I’m not alone in believing that dividend growth will return. The chart below shows that analysts expect dividend growth to gradually rebound to 7.7%. In this case, the company can afford to increase dividends as the net debt to EBITDA ratio is expected to fall to 2.1x in fiscal 2024 after hitting 3.7x during the pandemic.
So what about valuation?
Using market capitalization of $40 billion and net debt of $9.4 billion, we get an enterprise value of $49.4 billion. This is 12.0x 2023E EBITDA. In other words, we are expecting some growth, but I think that’s only fair given the situation.
Between 2016 and the pandemic, the stock averaged 12.5x. Note that I interrupted the pandemic because it disrupted the valuation chart due to the implosion of EBITDA.
I think the assessment is fair. Not only based on EV/EBITDA, which explains the company’s above-average growth, but also because of its high implied free cash flow yield of close to 6%, which I showed in This article.
Investors don’t pay too much for access to the company’s free cash flow, which is essential for investing in dividend growth.
Sysco is an attractive dividend growth stock that combines a number of advantages. First, it operates in an industry that is only semi-cyclical. Pandemics aside, revenues are relatively flat during economic downturns. It is also helpful if the company is able to report superior growth in a highly fragmented industry. With technology, good reputation and supply chain relationships, the company is poised for further penetration in the industry.
In the case of SYY, the implied free cash flow yield is high. This not only demonstrates that the stock is attractively valued, but also lays the groundwork for further debt reduction and accelerating dividend growth.
The stock isn’t a high-yield investment, but its 2.4% yield isn’t bad business. The balance sheet is healthy and long-term earnings should again outperform the S&P 500 if history is any indication.
I think it’s a terrific investment in the consumer staples industry, which comes with decent dividend growth.
(Disagree? Let me know in the comments!