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Sysco: A Food Distributor Paying Higher Dividends Every Year Since 1970

Founded in 1969, Sysco (SYY) is the largest global distributor of food, essentially acting as a middleman between food producers and retail consumers. 

The company provides a full line of food products and non-food items to more than 650,000 customer locations, including restaurants (62% of sales), schools and governments (9%), hotels and travel companies (9%), healthcare facilities (8%), and other foodservice customers (12%).

Sysco sells fresh and frozen meats (19% of revenue), canned and dry products (17%), frozen fruits, vegetables, and bakery items (15%), poultry (10%), dairy products (10%), fresh produce (8%), paper products (7%), seafood (6%), beverages (4%), janitorial products (2%), equipment (1%), and medical supplies (1%).

While Sysco has a presence in more than 80 countries, the U.S. is its most important region, accounting for more than 70% of total revenue. 

Sysco has increased its dividend every year since going public in 1970.

Business Analysis
Wholesale food distribution is a simple business. That is likely one reason why Warren Buffett bought into the industry in 2003 when he acquired McLane Company from Walmart for $1.5 billion.

The pace of change is very slow, and new innovations seem to pose little threat to the way the industry operates. At the end of the day, food manufacturers need a cost-efficient way to get their products to retailers, restaurants, and consumers.

The best operators offer prompt and accurate delivery of orders, a broad assortment of products, and competitive pricing. Since distributors are middlemen, their margins are very low (Sysco's operating margin has averaged less than 5% over the last decade), and players must either establish themselves as price or niche leaders in a given region.

Not surprisingly, Sysco’s scale plays a big advantage. Since its formation 50 years ago, Sysco has grown its annual revenue from $115 million to more than $60 billion (acquisitions have been a significant growth driver).

As the largest food products distributor in North America with approximately 16% share of the $300 billion foodservice market in the U.S., Sysco works with thousands of suppliers to offer the broadest assortment of products (over 400,000) on favorable terms. 

Few companies have the capital, supply chain network, and expertise to match Sysco’s assortment. For these reasons, Sysco is one of a handful of players that can serve national accounts. 

However, locally managed customers such as independent restaurants are more profitable for Sysco since they can't command meaningful volume discounts. In this market segment, the company generates nearly half of its revenue from Sysco-branded products which carry higher margins.

Besides being able to serve large and small businesses, Sysco's network of warehouses and distribution systems (more than 14,000 delivery vehicles) allows it to offer daily delivery to most of its customers and provide very competitive rates. 

With a dense delivery network around its warehouses (thanks to serving 650,000 customer locations), Sysco can leverage its fixed costs to offer more competitive pricing than other distributors that attempt to play in its geographic regions.

In addition to economies of scale, high capital costs, and product assortment, new entrants are also challenged by the supply contracts and long-term relationships Sysco has with many of its customers.

But while the food distribution business has several favorable characteristics that seem to ensure its durability, it is a very mature market. Research firm Technomic projects the foodservice market to experience just 1.5% real annual growth from 2019 through 2024.

As the largest player, Sysco is especially challenged to grow. The company has historically increased in size by acquiring market share, but there are few big enough deals left to really move the needle.

Most notably, Sysco made an offer to acquire the number two player in its market, U.S. Foods, for $8.2 billion in December 2013. The acquisition would have given Sysco 25% share of the national market but was blocked by the U.S. government, requiring Sysco to significantly alter its core strategic plan.

Less than two months after the merger was terminated, activist investor Nelson Peltz took a 7% stake in the company and secured two seats on the board of directors. Peltz brings meaningful experience in the food industry and has previously held positions in Kraft, Wendy’s, Pepsi, Mondelez, and several others.

Sysco ultimately turned more of its attention overseas, agreeing to acquire European food distributor Brakes Group for $3.1 billion in 2016, less than one year after its bid for U.S. Foods was shot down. 

This acquisition gave Sysco a solid foothold into Europe (especially the United Kingdom, France, and Sweden), which is necessary because the opportunity for needle-moving growth in the mature U.S. market is narrowing.

In recent years, management has turned their attention to smaller acquisitions, accelerating local case growth, and continued working capital improvements, all of which will further boost free cash flow.

The company plans to continue being generous with capital returns to shareholders as well, targeting a payout ratio between 50% and 60%over time which should allow for mid-single digit dividend growth.

Overall, Sysco seems likely to continue squeezing out modest profit growth over time and remain a force in the large and fragmented foodservice market.

Key Risks
There are several main risks to consider before investing in Sysco, starting with the highly competitive and mature nature of the food distribution business. 

Sysco competes with tens of thousands of domestic U.S. rivals, and smaller specialty distributors have taken some market share in the higher-margin restaurant business in recent years. The industry's competitive intensity means that maintaining above-average profitability could prove to be a struggle for the company over the long term.

Sysco is working to combat these challenges by expanding internationally, gaining greater scale, and offering a more localized approach to many of its customers. 

For example, the company offers locally produced foods and ingredients targeted more specifically at certain demographics. Sysco can also use its size to acquire some of the local and regional niche distributors to protect its business, if necessary.

Amazon could also affect the industry’s dynamics in the future, especially after acquiring Whole Foods in 2017. Amazon is the expert in warehousing, inventory management, and delivery capabilities, but it would be surprising if they went after Sysco’s core business.

Establishing all of the necessary supplier and restaurant relationships would require a lot of work, and Sysco’s margins are already quite thin. The inventory and delivery mechanisms needed for wholesale food are also quite different.

Perhaps the bigger risk would be if large national accounts or food producers decided to enter the distribution business themselves and cut out the middleman. However, this doesn’t seem to be happening today – probably because of the industry’s capital intensity and low value-add.

But consumer eating habits are evolving. A decline in consuming food away from home, or a shift in preferences toward restaurants that are not Sysco's customers, could make volume growth even more difficult. 

As consumers increasingly opt for organic and locally grown products, Sysco may also have to more aggressively shift the mix of its product portfolio to stay on trend, potentially incurring higher costs. 

Finally, it’s worth mentioning that swings in commodity prices (fuel, food prices, etc.) and consumer spending patterns (Sysco obtains the majority of its revenue from the cyclical restaurant industry) can impact Sysco’s results from time to time. However, these factors seem unlikely to have an impact on the company’s long-term earnings potential.

Closing Thoughts on Sysco
While Sysco may not be a high-flying growth stock, the company has proven its ability to help shareholders grow their income over time. In fact, Sysco has paid higher dividends each year since its founding 50 years ago.

Sysco is a simple, boring business, and its time-tested operations, well-known brand, economies of scale, defensive profile, and dependable cash flow generation make it a reliable dividend aristocrat.

The food distribution industry is very competitive and must continuously adapt to changing consumer tastes. However, it also provides essential services that are unlikely to go away anytime soon. 

All things considered, Sysco seems likely to remain an appealing long-term investment for conservative investors seeking sources of safe dividend income. 

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