Sysco Corporation (NYSE:SYY) Q2 2024 Earnings Call Transcript

Sysco Corporation (NYSE:SYY) Q2 2024 Earnings Call Transcript January 30, 2024

Sysco Corporation beats earnings expectations. Reported EPS is $0.89, expectations were $0.88. Sysco Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to Sysco’s Second Quarter Fiscal Year 2024 Conference Call. As a reminder, today’s call is being recorded. We will begin with opening remarks and introductions. I would like to turn the call over to Kevin Kim, Vice President of Investor Relations. Please go ahead.

Kevin Kim: Good morning everyone and welcome to Sysco’s second quarter fiscal year 2024 earnings call. On today’s call, we have Kevin Hourican, our President and Chief Executive Officer; and Kenny Cheung, our Chief Financial Officer. Before we begin, please note that statements made during this presentation that state the company’s or management’s intentions, beliefs, expectations or predictions of the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act, and actual results could differ in a material manner. Additional information about factors that could cause results to differ from those in the forward-looking statements is contained in the company’s SEC filings. This includes, but is not limited to, risk factors contained in our annual report on Form 10-K for the year ended July 1st, 2023, subsequent SEC filings, and the news release issued earlier this morning.

A copy of these materials can be found in the Investors section at sysco.com. Non-GAAP financial measures are included in our comments today and our presentation slides. The reconciliation of these non-GAAP measures to the corresponding GAAP measures is included at the end of the presentation slides and can also be found in the Investors section of our website. During the discussion today, unless otherwise stated, all results are compared to the same quarter in the prior year. To ensure we have sufficient time to answer all questions, we’d like to ask each participant to limit their time today to one question and one follow-up. Additionally, we want to make the audience aware of Sysco’s participation at the CAGNY Investor Conference on February 20th and our Investor Day on May 22nd in New York.

We hope you can join these events in person or virtually. At this time, I’d like to turn the call over to Kevin Hourican.

Kevin Hourican: Thanks Kevin and good morning everyone. Thank you for joining our call today. I’m very pleased with Sysco’s performance for the quarter. Our company is the market leader in a growing industry or size and scale matter. This past quarter, we demonstrated that important position of strength by delivering another quarter of double-digit earnings per share growth. Sysco delivered bottom-line growth through a combination of volume growth, disciplined margin management, and expense control. Our positive momentum from the first half of our fiscal year is expected to continue into the second half, and we remain confident in our full year growth expectations for sales and EPS. This includes 2024 adjusted EPS growth of 7% at the midpoint of our guidance range.

Sysco has improved how we leverage our scale through the Recipe for Growth strategy and we continue to deliver industry-leading profitability metrics as well as leverage our industry-leading strong balance sheet. Our confidence in the year has enabled us to increase our capital allocation to shareholders for the year. We are announcing today an increase of our stock buyback target for fiscal year 2024. We now expect to buy back approximately $1.25 billion of our stock this year up from our previously communicated $750 million. With the increased stock buyback and our industry-leading dividend yield, we will contribute more than $2.25 billion directly to our shareholders. Sysco’s strong balance sheet and free cash flow enable us to make these types of shareholder-friendly decisions while providing ample liquidity to fund the long-term growth of our business.

We are, as we say, play from a position of strength. So let’s get started with a brief highlight of the quarter on Slide number 5. Beginning with the top line, we delivered sales growth of 3.7%, a sequential improvement from Q1, driven by a combination of positive case volume growth and positive product cost inflation. Importantly, this included a sequential improvement in local case volume growth quarter-over-quarter and year-over-year. We will share more on that later. Turning to the bottom line, we posted over 11% growth in adjusted EPS, generating strong operating leverage. This is the fifth consecutive quarter of positive operating leverage and the 11th consecutive quarter of double-digit adjusted EPS growth. Kenny will provide more details in his financial section.

Today, I would like to update you on two topics I highlighted as priorities on our Q1 earnings call: Local case volume and supply chain productivity. During the quarter, we sequentially increased our case volume performance, growing our US foodservice segment 3.4% and delivering local case volume growth of 2.9%. We grew our market share profitably through our improvement efforts. Notably, this growth comes with the industry-leading profit margin rates you can expect from Sysco. The rate of volume growth does not include the benefit of Edward Don, which closed in late November, and we remain solidly on track to deliver our growth ambition versus the market this year. Importantly, the initiatives we outlined to drive local case performance earlier this year began to bear fruit this past quarter.

We are focused on improving sales execution. Our efforts are centered around properly serving our local customers in improving our local sales growth. A reminder of our local sales focus areas for fiscal 2024. First, we started adding incremental sales headcount in the second quarter and expect to continue hiring in the second half of fiscal year 2024 and in the coming years. The incremental headcount is targeted to optimize territory sizes and enhanced sales consultant effectiveness, demonstrating focused actions to deliver higher returns. The benefits from increasing our local salesforce will accrue over time as new colleagues complete their training, move up the productivity curve and settle into their territories. As previously indeed, we continue to expect to see the vast majority of the positive impact from our fiscal year 2024 hires impact fiscal year 2025 performance.

Second, we recently refined our compensation model to further motivate our sales consultants on win, win, win behaviors for Sysco, our customers and our salesforce. We can already see the impact of the compensation change, and we expect the impact of these recent changes to grow over time. We will continue to optimize our compensation program over time to ensure we are properly rewarding and motivating our sales team. Third, our focus on performance management continues with a hyper focus on customer visit frequency and sales consultant visit quality. These efforts are improving outcomes of our sales visits and can be closely tracked in our CRM tool. Leveraging technology to maximize the effectiveness of each customer visit remains a top priority and I am pleased with the impact of our sales leadership team in the past quarter.

Lastly, total team selling continues to gain traction. Our sales teams across broadline and specialty are working more collaboratively and we are leveraging our data to maximize the time allocation of our selling specialists in produce, protein and ethnic cuisine segments like Italian. All told, these interconnected actions increased our local case performance from Q1 to Q2 by 300 basis points. Importantly, the exit velocity of the quarter was even stronger as our performance improved each month of the quarter. We are confident in our ability to continue to grow local sales, while maintaining the positive momentum we have displayed in national sales. Next, I would like to provide an update on the progress we’ve been making within our supply chain.

We continue to improve the performance of our supply chain by focusing on operational excellence. Chart 9 displays our year-over-year operating profit improvement, driven by positive operating leverage, with gross profits growing at a faster rate than operating expenses. Our supply chain employees continue to move up the productivity curve due to improved colleague training and significantly improved levels of retention, especially within the driver position with improved retention comes improved outputs across the supply chain, lowering hiring expenses, lower training expenses, improved productivity, lower levels of product shrink, improved safety metrics and improved service levels to our customers. Each of these elements positively impact our P&L and the improvement drops straight to the bottom line.

We are extremely focused on continuing to improve colleague retention and productivity within our supply chain. Lastly, we continue to improve the rigor and discipline in our colleague staffing efforts. This includes better matching our hours worked to the volume of cases shipped and the difficult work of flexing down our staffing during lower volume periods. We will continue to refine our engineered labor standards that drive our staffing models, and we will increase the agility with which we match our staffing to our volume. Our Q2 results display a continuation of quarter-over-quarter progress in productivity gains, and we remain disciplined and focused on continuing that rate of improvement. These efforts will benefit the P&L in fiscal 2024 and will carry into 2025 and beyond.

We are bullish on our ability to continue to lower our cost to serve while simultaneously improving customer service levels. As I lift up from these two topics, improving sales effectiveness and improving our supply chain productivity, I would also like to communicate that we remain on track with our Recipe for Growth business transformation. Our digital efforts continue to advance. Our merchant teams continue to improve our product assortment, especially in Sysco brand. We are excited about the integration with Edward Don and how we can profitably grow our equipment and supplies business. We remain very pleased with the performance of our Greco Italian platform, and I am proud of our international business leaders for the compelling performance produced year-to-date from our International segment.

At our Investor Day in May, we will dive deeper into each of our Recipe for Growth pillars. Foodservice distribution is a space for size and scale matters, logistics scale, cold storage scale in both warehousing and transportation, technology scale, and sales force expertise and scale. We believe that no one is better positioned than Sysco to leverage global scale advantages in order to better serve customers and profitably grow the business. I am very pleased that fiscal 2024 is off to a strong start, as we are profitably growing our market share and continuing a track record of delivering compelling top and bottom-line growth. For the remainder of fiscal 2024, we remain hyper focused on the execution elements I highlighted today as well as advancing our Recipe for Growth strategy.

We are confident that these efforts will enable Sysco to deliver our financial plan. I’ll now turn it over to Kenny, who will provide a more detailed review of our financial performance. Kenny, over to you.

Kenny Cheung: Thank you, Kevin and good morning everyone. I’m going to build upon Kevin’s commentary with a couple of points. First, we have positive momentum as Q2 marked another milestone with record topline and bottom-line performance. Future results included sales and volume growth, along with strong cost of goods sold performance, resulting in adjusted gross profit dollar growth and margin expansion. Positive operating leverage was also driven by gross profit growing at a faster rate than operating expenses, demonstrating our disciplined margin management, which rendered adjusted EPS growth of over 11%. Second, we are excited about our first half performance and confidence in our positive momentum for the remainder of the year.

Therefore, we are increasing our share repurchases expectations from $750 million to $1.25 billion for FY 2024 versus the prior guidance. This will increase expected total shareholder returns, including dividends and share repurchases to approximately $2.25 billion for FY 2024. This is in addition to our continued reinvestment into the business, including M&A, such as the addition of BIX and Edward Don earlier this year. Capital allocation is a competitive advantage for Sysco as the strength of our balance sheet and free cash flow generation allows us to invest for growth and reward our shareholders at the same time. Now, turning to a summary of our reported results for the quarter, starting on Slide 13. For the second quarter, our enterprise sales grew 3.7%, with US foodservice growing 3.2%, international growing 9.6%, SYGMA and decreasing 1%, driven by planned exit of customers that did not meet our disciplined profit thresholds.

This planned exit along with strong supply chain productivity improvement, helped more than double our SYGMA profits this quarter, another prime example of our ROIC focus in action. Enterprise inflation was 1.1%. Additionally, US broadline inflation was slightly positive and our international segment was up 6.6%, all aligned with our expectations. Total US foodservice volume increased 3.4% and local volume was up 2.9%, a 300 bps sequential improvement from Q1. Please note, volume reporting includes slight benefits from the acquisition of BIX Produce. Our volume reporting does not include our Edward Don or Specialty Meat business based on their unique product attributes. We produced $3.5 billion in gross profit, up 4.9%. Adjusted gross margin improved to 18.2%, an increase of 21 bps.

Our gross profit dollar and margin percentage improvement reflected our ability to effectively manage product cost fluctuations driven by incremental progress from our strategic sourcing efforts and disciplined pricing. Penetration rates of Sysco brand products increased 22 bps to 46.9% in U.local and was essentially flat at 36.8% in US broadline. Overall, adjusted operating expense were $2.8 billion for the quarter or 14.4% of sales as we achieved another quarter of positive operating leverage. The strong management of expenses during the quarter was due to the positive impact of the variable labor planning tool and supply chain efficiencies that Kevin mentioned, and benefits from our previously announced $100 million of cost-out commitments.

We are on track to achieve this commitment for FY 2024 and the planning process for delivering incremental costs for future periods has already begun. Additionally, with the successful closure of our BIX and Edward Don acquisition, we are on pace to realize both top and bottom line synergies. Adjusted operating income growth of 7.6% in USFS, coupled with outsized profit contributions from our international and SYGMA segments, contributed to bottom line performance. Positive momentum continued in our International segment, with adjusted operating income growing 30.1% during the quarter. Our international results are a continuation of the robust growth and positive momentum in this segment over the past three years. The Recipe for Growth playbook is yielding dividends in the US and internationally.

In total, Q2 adjusted operating income was $745 million, up 9.2% and adjusted EBITDA was $927 million, up 11.6%. Turning to the balance sheet, which remains strong. We ended the quarter at 2.75 times net debt leverage ratio. This is in line with our target range of 2.5 to 2.75 times net debt leverage ratio. Our planned increase to the share repurchase program is already in action with an accelerated share repurchase program that was executed in early January. We ended the quarter with $11.2 billion in net debt that is well laddered and over $3.4 billion in total liquidity. Approximately 96% of our debt is fixed with the floating component offset by our cash reserves. Our strong investment-grade credit rating is a competitive advantage as evidenced by our team successfully issuing approximately $1 billion of new debt in November.

We are committed to our capital allocation strategy as seen on Slide 19, which includes a balanced approach with three elements: First, investing in the business for profitable and consistent growth; second, maintaining our investment-grade credit rating; and third, returning cash to shareholders, through dividends and share repurchases. Turning to our first half cash flow. We generated $856 million in operating cash flow and $527 million in free cash flow, growing 70% and 141%, respectively. This growth includes continued strong conversion rates from EBITDA to operating cash and free cash flow, and we remain on track to grow free cash flow for full year FY 2024. Our strong financial position enabled us to return $353 million to shareholders via share repurchases and dividends this quarter.

Looking forward to fiscal year 2024 guidance, we are reiterating net sales growth of mid-single digits to approximately $80 billion. Adjusted EPS is expected to grow to $4.20 to $4.40. This represents a 7% growth at the midpoint. Additionally, we expect positive operating leverage with gross profit growing at a faster rate than OpEx for the year. We continue to expect slightly positive rates of industry volume growth and inflation. This includes Sysco’s US broadline remaining inflationary in the second half of the fiscal year. Our planned top line also includes benefits from M&A activity consistent with previous disclosures for an average annual contribution of 50 to 100 basis points of growth. We will continue to opportunistically evaluate accretive acquisitions, but the remainder of FY 2024 will focus on integration efforts, capturing synergies for accretive acquisitions like Don and returning excess cash back to shareholders through share repurchases and dividends.

For the second half and over the long-term, we expect to win market share, profitably and consistently. Our efforts will also focus on strong cash generation with conversion rates, ultimately feeding our plans to grow and reward our shareholders. Thank you for your time today. With that, operator, we are now ready for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Jeff Bernstein with Barclays. Please go ahead.

Jeff Bernstein: Great. Thank you very much. I had one question and then one follow-up. The question on the US local case volume, the 2.9%. It’s nice return to growth on a one-year basis and like you said, a sequential acceleration on a two-year basis. Just wondering if you could talk about your level of confidence in sustaining that accelerating growth, maybe prioritize the most important drivers of that momentum. I think you mentioned that momentum actually built each month of the fiscal second quarter, and therefore, a strong exit rate. So I’m just wondering if you could provide some context, especially as someone was talking about maybe a slowdown that has been seen across much of the industry in January. Any thoughts there would be great. Thank you.

Kevin Hourican: Good morning, Jeff. Thank you for the question. This is Kevin. We’re confident in our ability to continue to improve in local sales. As you just said, the 2.9 is an average — weighted average, obviously, across the three months. And sequentially, the quarter improved each and every one of those months. So we are confident in our ability to continue to make progress in local case volume growth. And at the historic profitability metrics that Sysco industry-leading will continue to produce. So it’s profitable local case growth. The biggest drivers, I’d say the performance management on the sales consultant side is the most immediate lever. The compensation change would be the second most impactful measure and total team selling followed up by the increased SC headcount would be the third and the fourth of the four things I said on the call, if I ranked them from an impact perspective.

As it relates to the second half of your question on January, there has been a slowdown in January. I would describe it more as a blip, a bump in the road, if you will. There’s a couple of factors driving the January. Week one of January had a calendar unfavorability tied to a holiday and where it fell historically cold weather. I hate the W word. I never used the W word, but there was some extraordinary weather in January, which made it awfully difficult to make deliveries to customers in large swaths of the United States. That’s backed up by the credit card data from the major banks that consumption that food-away-from-home was down in January. Jeff, I’m not overly concerned about that. It’s the lowest volume month of the year that there’s going to be a blip or a bump you’d want it to be in that month.

So, goes March, so goes the quarter. And we’ve got levers that we can pull on the year to go, and I toss to Kenny for any additional comment in that regard.

Kenny Cheung: Hey Jeff, good morning. On January, I agree with Kevin, what we’re seeing right now. While volume has been slightly impacted. We have the ability to flex labor and mitigate the impact of lower volume with our labor [ph] planning tool that we talked about, and that is in conjunction with the disciplined engineering labor standards that we’ve implemented. However, weather also impacts over time, productivity, customer returns, delivery costs, which we will mitigate throughout the fiscal year with levers in our P&L. Therefore, the full year guidance remains intact. In terms — Kevin talked a bit about local in the US, one comment is local international. As we know, international is roughly 20% of our business. And we’ve replicated some of the RFG, Recipe for Growth playbook there.

And we are seeing nice growth from our Canadian business and our European business, which is both up roughly 80%, and it’s really driven by new customers, penetration, and customer retention. So, we are excited and we continue to invest and capture growth with pace and discipline.

Jeff Bernstein: Got it. And just my follow-up on the fiscal 2024 guidance. I know from a very high level, you reiterated the mid-single-digit topline and the 5% to 10% EPS growth, I think you called out 7% at the midpoint. I’m wondering if you could share anything that might have surprised you on the positive or negative side in the first half of the year, especially because I think you said 7% at the midpoint. You’ve also talked about in the first half of the year, double digit and 11 consecutive quarters of double-digit EPS growth. So what potential incremental challenges are you seeing in the second half, especially as you’ve got an incremental $500 million bump in share repurchase to come. So, just wondering your thoughts on the back half of the year EPS growth relative to the recent momentum you’ve had. Thank you.

Kevin Hourican: Okay. So, let me unpack to questions, what surprised me and what are some takeaways in the first half of the year. I think the biggest thing is Sysco has proven we can manage the business under various different environments. If you remember, Q1 was slightly deflationary in the US. Q2 was slightly positive in — for the US. And in both quarters in the first half, we delivered operating margin expansion of roughly 26 bps and also GP margin dollar expansion and GP margin expansion of 28 bps. So, again, I think first half was a really good proof point that under any circumstance, Sysco has the levers on the P&L to drive positive and consistent growth and being able to drive quality of earnings on the cash flow side.

So, that’s about more in the first half. In terms of the full year guidance, let me just provide a bit more color. So, we do expect overall this year, lower overall market volume growth versus 2023. However, continued market share gains from our company, profitable growth at Sysco. Inflation, as I mentioned on the last earnings call, Q2 came in slightly positive aligned with our expectation. In the back half, we are still — remain consistent with what we said on both the first earnings call that we had at the end of last year and the previous 90 days ago. We expect the back half to be slightly positive on inflation. We still have two quarters ago, but I believe that Q2 slight positive inflation provides us comfort around our original assumptions.