Sysco's Scale and Private-Label Mix Position It Well Despite Challenging Industry Backdrop

Equity Analyst

Sean Dunlop

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We believe Sysco possesses a narrow moat, rooted in its cost advantage. We surmise the firm benefits from lower distribution cost given its closer proximity to customers, augmented by scale-enabled cost advantages such as purchasing power and resources to provide value-added services to its customers. While COVID-19 created a very challenging environment, the U.S. food-service market has fully recovered, with volumes exceeding pre-pandemic levels as of March 2022. Sysco has emerged as a stronger player, in our view, with $2 billion in new national account contracts (10% of pre-pandemic national account sales) and a 10% increase in independent restaurant customers. 

In 2021, Sysco laid out its three-year road map, termed "recipe for growth," which was being funded by the elimination of $750 million in operating expenses in fiscal 2021 and fiscal 2022. The plan should allow Sysco to continue to outgrow the market, with management targeting a growth rate 1.35 to 1.5 times that of the market, underpinned by investments to eliminate customer pain points and the deployment of initiatives like the elimination of minimum order sizes, increased delivery frequency, and lengthened payment terms. Sysco also improved its CRM tool, which now uses data analytics to enhance prospecting, rolled out new sales incentives, and launched an automated pricing tool, which sharpens its pricing competitiveness while freeing up time for sales reps to pursue more value-added activities like securing new business. 

In our view, Sysco competes primarily along the lines of product availability, on-time delivery, and quality of auxiliary services, so we view regional organization in the U.S. and an augmented emphasis on product specialists (who focus on increasing adoption of Sysco’s specialized product categories such as produce, fresh meats, and seafood) as cogent. The deployment of teams that specialize in various cuisines (Italian, Asian, and Mexican) should drive market share gains in ethnic restaurants. 

Looking abroad, Sysco has a new leadership team in place for its international operations, giving us more confidence that execution will improve.

Business Strategy & Outlook

We believe that Sysco possesses a narrow moat anchored in its cost advantages, underpinned by both its closer proximity to customers, which lowers distribution cost, and its scale, which provides the firm with superior purchasing power as well as resources to provide clients value-added benefits such as technology tools, consultancy, and a high level of service. 

In our view, Sysco’s vast and unmatched distribution network of 190 U.S. distribution facilities places it in closer proximity to its customers, providing it with a distribution cost advantage. This compares with 78 food-service warehouses for Performance Food Group and 70 for US Foods at the end of 2022. Supporting our contention, the firm's distribution expense as a percentage of sales clocked in at 5.8% between 2020 and 2022, meaningfully below US Foods' 7% print (Performance's distribution expense is lower, but reflects a higher mix of national accounts).

We believe Sysco’s purchasing power also provides an advantage as Sysco remains the largest foodservice distributor in a fragmented U.S. market by a wide margin, with high-teens market share and $54 billion in 2023 U.S. foodservice revenue (even larger if the U.S. portion of the firm's hotel and Sygma quick-service restaurant businesses are included). Even the largest restaurants can’t match this purchasing power; only the top U.S. restaurant, wide-moat McDonald's, is in the ballpark, with $49 billion in 2022 U.S. systemwide sales. Thereafter, revenue falls off steeply, with number-two Starbucks reporting $26 billion and number-three Chick-Fil-A booking $19 billion. While Sysco hasn’t always leveraged its purchasing power scale (historically, each distribution center operated independently), in 2014 it began an effort to consolidate purchases, which drove a 200-basis-point improvement in gross margin. While we acknowledge that US Foods has also realized margin improvement from consolidating purchases, we do not believe it realized the same degree of benefits as Sysco given its smaller size, with the company's gross margins lagging Sysco's U.S. broadline margins by about 200 basis points. 

Sysco also uses its scale to differentiate itself from smaller regional and local players by offering clients products and services that smaller distributors cannot offer, such as technology tools that help their customers better manage their businesses. These systems provide restaurateurs with integrated systems that help them manage their point-of-sale transactions, control inventory, calculate menu profitability, facilitate online orders and reservations, and schedule employees. In addition, these systems allow clients to input their own orders, freeing up significant time for Sysco’s salesforce so the reps can engage in more value-added activities, such as consultative selling to increase penetration of existing accounts or following leads to secure new business. Sysco’s clients have embraced online ordering, as 70% of the firm’s orders are placed online. Sysco has said that for clients who use these tools, the distributor gains a higher share of wallet and it also improves client retention (without quantifying), which in our view, suggests that these tools enhance Sysco's competitive advantage. 

Sysco also seeks to differentiate itself from smaller distributors by offering independent restaurants consultancy services. Sysco offers operations consultants that advise clients on improving operations and profitability, chefs that advise on menu selections, and graphic designers to design menus and marketing campaigns. The team offers clients a complete review of their operations and makes personalized recommendations to the entrepreneur. Sysco completes 50,000 such reviews each year, which it reports are in high demand. These services are provided free of charge, as a benefit of partnering with the firm. Smaller distributors have not been able to replicate this specialized service, and as such, we think it contributes toward Sysco’s competitive edge. Even though UniPro Foodservice, a distributor cooperative with over 400 members that collectively generate over $130 billion in revenue, does offer its members information on consumer and menu trends, as well as tips to help restauranteurs improve their marketing, in our view, this does not compare with Sysco’s thorough and personalized business review services. 

We think Sysco’s scale also provides the firm with the resources to invest in its business to ensure that it is able to deliver a very high level of service. This includes forecasting tools to ensure that the right product is on hand, the fleet to ensure the trucks are running on time, technology to efficiently route the fleet, and financial systems to ensure orders are processed and billed correctly. As a result, excluding 2021 and 2022 when labor and product shortages were common, Sysco averages a 98.5% service level, the percent of orders delivered with the requested product (no substitutions), within the designated delivery window, and billed accurately. From our vantage point, these service levels are likely aiding the firm’s ability to gain market share over time. While others, including US Foods, have failed to disclose this metric, we suspect competitors are unable to match these high service levels, given Sysco's industry-leading net promoter score, a measure of customer satisfaction.

Sysco also uses its scale to offer clients their own lines of private label products. While there is evidence that these products enhance distributor margins, we do not contend that these offerings enhance the distributors’ competitive advantage, as they are ultimately replicable. The most popular private label offerings are relatively easy to duplicate, as they are commodity-like items such as cuts of meat, minimally processed produce, and dairy products. We acknowledge that private label brands have become a significant portion of distributors’ businesses, composing 47% of Sysco’s local restaurant cases in fiscal 2023. However, we attribute that to a push from the distributor to enhance its margins, as opposed to gaining a competitive edge. Sysco prefers these products as they have twice the margin of nationally branded product, and the distributors incentivize their sales reps to promote these items to clients. 

In addition to other distributors, food-service clients can also source their food and supply needs from cash and carry locations such as Costco, Sam’s Club, and specialized restaurant supply stores such as Restaurant Depot. Technomic, a food-service industry research firm, estimates that these stores combined maintain about 10% market share of the food-service supply industry. While these stores don’t offer the convenience of delivery, do not have the same breadth of product, and may not consistently carry the same items, they offer appealing prices on many products that food-service operators regularly use. This channel is particularly compelling during periods of uncertainty, when food-service operators are most cost sensitive. For example, according to Sysco, during the 2008-09 recession, cash-and-carry share gains accelerated. Similarly, US Foods disclosed that its cash-and-carry outlets proved more resilient than delivery services during the pandemic. While Sysco notes that the channel’s market share has been stable excluding periods of significant disruption, we believe the channel represents a viable competitive threat to distributors. Sysco is currently testing a cash-and-carry concept in Latin America, although it has not announced plans to open stores in the U.S. 

There is ample quantitative evidence of Sysco’s competitive edge. Sysco has reported organic market share gains, operating margins superior to its direct peers, and steady economic profits. Over the five years preceding the pandemic (calendar 2015-19), Sysco’s U.S. food-service segment average annual organic revenue growth rate was 3.3%, modestly ahead of the 3.1% average annual industry growth rate over the same period, according to Euromonitor. Similarly, during the pandemic, Sysco secured $2 billion in net new national account business and about 13,000 new independent restaurant partnerships, despite a contracting industry. Since the pandemic, Sysco has continued to gain market share, targeting 1.2-1.5 times market rates of growth. Together, we think the firm’s cost advantages, underpinned by closer proximity to customers and its scale, facilitate market share gains by allowing the firm to offer customers similar products and services at a lower price, or offer customers superior products and services at a comparable price. Sysco also maintains higher operating margins than its direct peers. In the last five years (2019-23), Sysco reported an average U.S. adjusted operating margin (broadlines and Sygma combined) of 6%, compared with 2%-2.5% at U.S. Foods and roughly 2% at Performance. Finally, Sysco consistently reports ROICs far in excess of our 8% estimate of the firm’s cost of capital. Over the past 10 years, the firm’s ROICs including goodwill have ranged from 10% (due to the pandemic) to 17%. Our forecast calls for continued economic profits, with ROICs ranging from 17% to 22% over the next 10 years.

We assign the firm a narrow moat rating, as we believe the firm will maintain this advantage for at least the next 10 years. However, we do not have the visibility or conviction that Sysco can maintain its advantage for at least 20 years, required for a wide moat rating, due to the evolving competitive environment, with consolidating direct competitors, the firm’s lack of pricing power and related gross margin volatility, the growth of restaurant group purchasing organizations, or GPOs, and the growth of cash-and-carry alternatives, such as Costco, Sam’s Club, Restaurant Depot, and US Foods' Chef'store.

Narrow

Economic Moat

Sysco

Sysco Corp. engages in selling, marketing, and distribution of food products to restaurants, healthcare and educational facilities, and lodging establishments. It operates through the following segments: U.S. Foodservice Operations, International Foodservice Operations, SYGMA, and Other. The U.S. Foodservice Operations consists of U.S. Broadline operations, custom-cut meat and seafood companies, FreshPoint, and European Imports. The International Foodservice Operations segment includes broadline operations in America and Europe, which distribute a full line of food products and a wide variety of non-food products. The SYGMA segment represents its customized distribution subsidiary. The Other segment covers hotel supply operations. The company was founded by John F. Baugh in 1969 and is headquartered in Houston, TX.

Earnings data Q1 2023

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Sysco Corp. engages in the selling, marketing, and distribution of food products to restaurants, healthcare and educational facilities, and lodging establishments. It operates through the following segments: U.S. Foodservice Operations, International Foodservice Operations, SYGMA, and Other. The U.S. Foodservice Operations segment consists of U.S. Broadline operations, custom-cut meat and seafood companies, FreshPoint, and European Imports. The International Foodservice Operations segment includes operations outside of the United States which distribute a full line of food products and a wide variety of non-food products. The SYGMA segment represents U.S. customized distribution operations serving quick-service chain restaurant customer locations. The Other segment covers hotel supply operations. The company was founded by John F. Baugh in 1969 and is headquartered in Houston, TX.

Sysco (SYY) has been encountering slower overall industry market volume growth, product cost inflation, rising operating expenses and a high tax rate.

Reasons Why You Should Avoid Betting on Sysco (SYY) Now

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CALERA, Ala., Sept. 11, 2023 (GLOBE NEWSWIRE) -- Sysco Central Alabama announced today that Natonia Smith, Forklift Operator, will represent Sysco at the International Foodservice Distributors Association (IFDA) National Championship in Orlando, Florida, October 12-14, 2023.

Sysco Central Alabama Recognizes Natonia Smith, Industrial Athlete Headed to IFDA National Championship

LAS VEGAS, Sept. 11, 2023 (GLOBE NEWSWIRE) -- Sysco Las Vegas announced today that Randall Bennett, Delivery Driver, will represent Sysco at the International Foodservice Distributors Association (IFDA) National Championship in Orlando, Florida, October 12-14, 2023.

Sysco Las Vegas Recognizes Randall Bennett, Industrial Athlete Headed to IFDA National Championship

KANSAS CITY, Kan., Sept. 11, 2023 (GLOBE NEWSWIRE) -- Sysco Kansas City announced today that Luis Escribano, Warehouse Selector, will represent Sysco at the International Foodservice Distributors Association (IFDA) National Championship in Orlando, Florida, October 12-14, 2023.

Sysco Kansas City Recognizes Luis Escribano, Industrial Athlete Headed to IFDA National Championship

VENTURA, Calif., Sept. 11, 2023 (GLOBE NEWSWIRE) -- Sysco Ventura announced today that Richard Edmonds, Driver, will represent Sysco at the International Foodservice Distributors Association (IFDA) National Championship in Orlando, Florida, October 12-14, 2023.

Sysco Ventura Recognizes Richard Edmonds, Industrial Athlete Headed to IFDA National Championship

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Sysco (SYY) has been grappling with the adverse impacts of product cost inflation, escalating operating costs and expenses, and foreign exchange headwinds.

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HOUSTON, Aug. 31, 2023 (GLOBE NEWSWIRE) -- Sysco Corporation (NYSE:SYY) today announced that the Company will webcast its presentation at the Wells Fargo 6th Annual Consumer Conference on Thursday, Sept. 21, at 11:00 a.m. EDT.

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Sysco SYY, +0.28% has named Greg Bertrand as executive vice president, global chief operating officer, effective Sept. 1.

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HOUSTON, Aug. 24, 2023 (GLOBE NEWSWIRE) -- Sysco Corporation (NYSE:SYY) today announced that the Board of Directors declared a regular quarterly cash dividend of $0.50 per share, payable on Oct. 27, 2023, to common stockholders of record at the close of business on Oct. 6, 2023.

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Sysco Corporation (NYSE:SYY ) Q4 2023 Earnings Conference Call August 1, 2023 10:00 AM ET Company Participants Kevin Kim - VP of IR Kevin Hourican - President and CEO Kenny Cheung - CFO Neil Russell - Chief Administrative Officer Conference Call Participants Edward Kelly - Wells Fargo Joshua Long - Stephens Inc. John Heinbockel - Guggenheim Securities Kelly Bania - BMO Capital Markets John Ivankoe - JPMorgan Alex Slagle - Jefferies Operator Welcome to Sysco's Fourth Quarter Fiscal Year 2023 Conference Call. As a reminder, today's call is being recorded.

Sysco Corporation (SYY) Q4 2023 Earnings Call Transcript

Sysco's (SYY) fourth-quarter fiscal 2023 results reflect higher sales and earnings on volume gains, market share growth, the progress of the Recipe for Growth plan and solid cost management.

Sysco's (SYY) Q4 Earnings Beat Estimates, Sales Advance Y/Y

News for Sysco Stock (SYY)