Enter the Peltz Plan
Since Peltz’ announcement of his large stake in Sysco, the company’s stock price has risen from around $36 a share to around $41 a share – a roughly 14% increase.
Despite a run up in the company’s stock price, Sysco has announced it will engage in large share repurchases. The company is planning on repurchasing $3 billion in shares over the next two years. This comes to 12% of the company’s market cap at current prices.
SYSCO Corporation (NYSE:SYY) is attempting to boost its earnings-per-share through debt-fueled share repurchases. The company recently raised $2 billion from issuing debt. Sysco will use $1.5 billion of these funds for its previously announced share repurchases.
Share repurchases can be beneficial for shareholders, but they are not always beneficial. When shares are repurchased when a stock is trading above fair value, share repurchases destroy shareholder value in the same way that paying $1.00 for three quarters destroys value.
Sysco Valuation
Sysco had adjusted earnings-per-share of $1.84 in its fiscal 2015. The company is currently trading at a price-to-earnings ratio of around 22.5.
For a company to be fairly valued at a price-to-earnings ratio of 22.5, it needs to have a strong and durable competitive advantage, a shareholder friendly management, and excellent growth prospects.
Sysco’s competitive advantage has been in decline over the last 5 years. While it certainly still has a competitive advantage thanks to its industry leading size and scale, the company is less secure than many other Dividend Aristocrats.
Sysco does have a very shareholder friendly management with a long history of dividend increases as well as a commitment to repurchase shares.
The company’s growth prospects are mediocre at best, unfortunately. Earnings-per-share have grown at just 3.4% a year over the last decade. The company has seen sales grow at 4.5% a year over the same time period. These are not numbers that justify a 22.5 price-to-earnings ratio.
Over the last decade, Sysco has traded for an average price-to-earnings ratio of around 18. The company appears to be overvalued at current prices.
As a result of its current high valuation, I believe Sysco’s management should forego share repurchases until the stock’s price-to-earnings ratio falls at or below 18.
Recession Performance
Sysco managed the Great Recession of 2007 to 2009 well and saw only modest earnings-per-share declines.
The company saw declines in restaurant orders as consumers eat out less during recessions which in turn reduces demand for Sysco’s restaurant products.
Despite this, earnings-per-share did not fall significantly. The company’s earnings-per-share from 2007 to 2010 are shown below to show how the company handled the Great Recessions and subsequent recovery:
- 2007 earnings-per-share of $1.60
- 2008 earnings-per-share of $1.81
- 2009 earnings-per-share of $1.77
- 2010 earnings-per-share of $1.99
Final Thoughts
SYSCO Corporation (NYSE:SYY) may very well improve its margins in the short-run. In the long-run, the company’s slowly declining competitive advantage in a highly competitive industry does not bode particularly well for shareholders.
Nelson Peltz is one of the best practicing activist investors today. I certainly wouldn’t bet against him. At the same time, Sysco shares have already seen a substantial price run up. As Warren Buffett says:
“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
To be fair, Sysco’s industry isn’t terrible – but it is highly competitive and has very low margins. Additionally, it is very difficult for businesses to differentiate each other in the food distribution industry.
Instead of Sysco, dividend growth investors should consider this recent Nelson Peltz investment.
Disclosure: None
