Sysco Corporation

Moat: 3/5

Understandability: 1/5

Balance Sheet Health: 4/5

Sysco Corporation is the largest global foodservice distributor, delivering food and related products to a vast network of restaurants, healthcare facilities, educational institutions, and other establishments.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Sysco operates as an essential intermediary in the food service supply chain, bridging manufacturers and producers with end-users, its business model is straightforward: acquire products from numerous suppliers and distribute them to its diverse customer base. This model leverages a vast distribution network and a large customer base. However, it has limited influence on price.

Business Overview

Revenues Distribution: Sysco’s revenue streams are primarily derived from the sale of food products (both fresh and frozen, as well as other perishable and nonperishable goods), and non-food products such as disposable tableware, kitchen supplies, and cleaning supplies.

  • Sysco operates through two main segments: U.S. Foodservice and International Foodservice Operations, with the former historically accounting for the vast majority of revenue, but recently international operations are also gaining importance. In fiscal year 2023, U.S. Foodservice generated $54.3 billion in revenue, while International Foodservice contributed $17.5 billion, and the combined revenue reached $76.3 billion.

Industry Trends:

  • The food service industry is characterized by stable long-term growth as a result of the slow pace of change in consumer preferences. However, industry structure is evolving as consolidation among both distributors and their clients becomes more common. Also, technology is playing an increasing role in inventory management and ordering, putting pressure on legacy distributors. There are some pressures due to current inflation and macro-economic conditions, but the industry is fairly insulated from those shocks due to the necessity of these products.
  • The industry is very fragmented and dominated by small and local players, hence scale is extremely important.
  • The restaurant industry and the foodservice industry in general is experiencing a shift toward more casual dining, smaller venues, increased food delivery, and more diversified menus. These changes in consumer behaviour are influencing what products and services they demand. The demand for prepared foods has been rising in the last few years as well.
  • Also, supply chains have been disrupted over the last few years due to covid-19 and the war in Ukraine. These issues are still ongoing, and it’s hard to determine the true impact, but the management expects it will continue to impact their operations.

Margins:

  • Sysco’s operating margin in 2023 averaged 3.5% with net earnings of $1.3 billion; margins fluctuate over time depending on inflation, supply chain issues, product mix and other factors. The company’s margins are usually tied to the sales volume. So, an increase in sales volumes improves their margin. Gross margins are typically around 20% to 21%, while EBITDA margin hovers around 6% to 7%. These are very low margins, so scale and efficiency is very important for this business. However, these low margins also act as barriers to entry because most companies aren’t profitable with these thin margins.

Competitive Landscape:

  • Sysco is the biggest player in a highly fragmented industry, with the top ten distributors accounting for less than 30% of the market share. They compete with regional and local distributors, as well as direct suppliers in the foodservice industry.
  • Key competitors include US Foods, Performance Food Group, and a variety of regional and local players. The industry is intensely competitive as each distributor strives to secure supply contracts and acquire new customers.

What Makes Sysco Different?

  • Sysco’s biggest competitive advantage comes from its vast and unparalleled scale, which enables it to secure favorable terms from its suppliers. Its extensive distribution network allows the company to reach a larger number of customers more effectively than its competitors and create economies of scale.
  • The company has a broad range of products, which gives it an advantage over competitors who offer only a limited number of products or services. In an industry where time and efficiency is extremely important, this is a key differentiator.
  • Also, the company provides value-added services to its customers, which are very important to retain clients. These include supply chain solutions, business tools, training programs, and other similar services.
  • Another important competitive advantage lies in the strong relationship with their customers, which tend to be long-term and sticky. It is extremely tough for companies to switch to their competitors due to the integration the company has in their clients’ daily operations. This in turn leads to stable and high revenue generation over the long run.

Financial Analysis

Revenue Growth: Sysco’s revenue has been generally increasing, reflecting the growth of the food service industry, and its increasing share of the market. In fiscal 2023, total sales grew by 11.7% to $76.3 billion, driven by volume increases and inflation in food costs, whereas organic revenue growth was around 9.7%.

The company’s revenue growth has been very stable and predictable, but future revenue increases are going to be slower because the overall market is becoming more saturated. Most of the revenue growth is going to come from small acquisitions and more efficient internal operations.

Profitability: Gross profit margins are quite consistent, but they aren’t as high as one would expect due to the competitive nature of the industry and the company’s position in it. Net profit margins have increased in recent years but are still below 5%, reflecting high operating costs.

Profit margins for Sysco are generally low. Improving efficiencies and supply chain costs will be key for the company to improve its profitability, especially in the long run.

Balance Sheet: Sysco has a robust balance sheet. The company has enough cash to cover its short term debts. Also, the leverage is around 2:1. It’s important to note that the company has huge goodwill due to a lot of acquisitions it has performed over the last few years. It’s extremely important that they have acquired companies with durable competitive advantages.

The balance sheet is healthy, but debt is something to watch for in the future. It is also important to determine if the company has been good at their acquisitions since they have a high portion of its assets in goodwill.

Cash Flow:

  • Sysco has stable positive cash flows from operations, which reflect the consistency of their business. However, capital expenditures are also substantial due to the nature of the logistics industry. Free cash flow is often below net earnings for the company. This is not concerning because of the nature of the business, but it should still be noted.

Key Financial Metrics:

  • Return on invested capital (ROIC) is around 10%, which is a good, but not amazing, figure. The company’s goal is to increase this to around 15%.
  • The debt-to-equity ratio has been fairly steady in recent years, showing the management’s consistency to how it manages its business.
  • Price-to-earnings ratio is about 20, which is reasonable given its stability and market leadership.
  • Also the company pays an attractive dividend which is increasing every year.

Moat Analysis

Rating: 3/5

While Sysco is the largest and most dominant player in its industry, its moat isn’t extremely wide. The company definitely has a competitive advantage, but it may not be sustainable over an extremely long time period.

  • Scale: Sysco’s massive distribution network and size create substantial economies of scale. This is very important, and gives them an edge over competitors, because very few companies can build or compete with such an enormous supply chain system, but, at the same time, it also invites strong competition.
  • Customer Switching Costs: The high switching costs associated with its diverse product offerings and services create significant customer lock-in. It is just too much of a hassle for a big client to shift their operations to a competing supplier.
  • Brand: While not as visible as consumer brands, Sysco has built a reputation for quality, reliability, and wide product ranges within the food service industry. This does provide a competitive edge but isn’t as strong of a brand advantage.
  • Not Extremely Durable: Although its position appears strong for the near future, Sysco’s business is ultimately a middleman and its position can be challenged if food producers decide to directly engage end users.

Risks

Despite Sysco’s established position, a few risks could undermine its moat and hurt the business:

  1. Intense Competition: The food distribution industry is intensely competitive, with many regional players that compete aggressively on price.
  2. Supply Chain Disruptions: The company is vulnerable to disruptions in its supply chain, such as changes in demand patterns and external geopolitical and economic events.
  3. Food Inflation: The high volatility in food prices can impact their profitability and also create uncertainty in the supply chain. This is a continuing and significant threat to their operations.
  4. Technological Disruption: Technology advancements in ordering and supply chain tracking can threaten its existing infrastructure and also add competitive pressures. If the company doesn’t adapt well and adopts the latest technologies in their infrastructure and operations, it can significantly hurt them in the long run.
  5. Large Acquisitions: Although acquisitions are necessary for the company’s growth and economies of scale, poor integration of acquired companies can seriously hurt their balance sheet and long term growth.
  6. Labor Costs: Since food service companies require a large workforce, higher labor costs could significantly hurt their margins in the long run. Also, labor shortages can severely impact their day to day operations.

Resilience: Sysco’s business model focuses on the daily necessity of feeding people, thus ensuring some resilience. Moreover, their strong customer relationships and a sticky client base may prevent any significant decrease in revenues. Management also has a strong emphasis on streamlining operations and reducing costs, which would help them survive in periods of slow economic growth or uncertainty.

Understandability

Rating: 1/5 While Sysco’s core operations are easy to understand, it is a very large business with multiple different revenue streams and services. There are many moving parts to the business and a deep dive may be required before a better understanding. But their main operations which are acquisition, storage, and distribution of goods are easily understandable. Overall, it is not a difficult business to understand.

Balance Sheet Health

Rating: 4/5

Sysco’s balance sheet is quite solid. Debt is not exceedingly high, and cash flows are consistently positive. While goodwill and acquisitions form a big chunk of their assets, if the company maintains the efficiency that they have had over the past few years, then they will be fine. The company has a robust balance sheet, with the ability to withstand some market volatility.

Recent Concerns

The company, similar to many others, has faced strong headwinds in the past year due to economic downturns. The company has had difficulties passing on input cost increases to its customers, so margins have been impacted over the last few quarters. However, management is taking steps to improve the operational efficiency of the company and reduce costs while streamlining operations. Management has been doing a decent job navigating these issues so far.

  • Also, in recent earnings calls, the management has stressed upon its goals to reach its long term average operating margins of 7% to 8% by streamlining their operations and investing in long term capabilities.