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Sysco Corporation (NYSE:SYY) is North America’s largest food distributor. With over 400,000 customers in the United States,^[1] Sysco supplies food, kitchen equipment, cleaning supplies, and serving ware to restaurants, schools, hospitals, and hotels.^[2] In the highly competitive food distribution business, Sysco benefits from economies of scale. The company has led the food distribution industry in consolidation with 145 acquisitions since 1970.^[3] Through these acquisitions and its own capital expenditures, Sysco now operates 180 distribution centers across the United States, giving it the largest reach of any distribution company in North America.^[4] In March 2009, the company expanded internationally, purchasing Irish distributor Pallas Foods LTD. This marks a departure from previous US consolidation strategy and signifies the company's new global expansion goals.^[5] The company's largest client, Wendy's International (WEN), accounts for 5% of sales and is the only large fast food chain to use an outside distributor.^[6]

Though transportation businesses are highly susceptible to changes in oil prices, Sysco shielded itself from increases from diesel fuel prices in 2007 by locking in $44.5 million in diesel fuel commitments through the end of that year. ^[7] In July and August 2008, the company locked in 60% of its fuel needs for 2009 at record high prices.^[8] Because of this, Sysco will not fully benefit from the fall in oil prices until 2010. However, the company estimates that it will be able to recover 50% of the total increase in fuel prices in 2009 through fuel surcharges.^[8]

Company Overview

Business Financials

SYY Sales by Customer Type^[6]

Sysco Corp. provides food related services to both traditional customers (schools, private restaurants and institutions) and chain restaurants. Sysco's customers are well diversified as restaurants make up only 63% of total sales.^[6] According to industry sources, roughly 50% of all consumer food expenditures are spent on meals-away-from home. Even during an economic downturn, Sysco still has a significant number of educational, healthcare, hospitality, and other customers whose orders are more stable.

Revenue in fiscal 2008 rose 7.1% to $37.5 billion from $35 billion in 2007; net earnings were $1.11 billion, a 10.5% increase from $1 billion in 2007.^[9] The increase in revenue was mostly due to increases in selling prices as the result of food inflation while total volume of sales remained constant.^[10] Although gross margin only rose by 6.5% in 2007, operating expenses rose by a smaller 5.3%, causing operating income to increase. This relatively smaller increase in operating expenses reflects Sysco's increased efficiency in fleet routes and fuel economy.^[8]

Sysco is the largest food distributor in North America with approximately 16% of the $231 billion annual US and Canada food service market.^[11] Sysco distributes a variety of products including both brand name merchandise and products branded with the company's own trademark. ^[12]

Sysco is focused on improving its operational efficiency through three supply chain improvement initiatives. The first involves the construction of five to seven regional redistribution centers that will optimize regional distribution by acting as a central warehouse for Sysco's suppliers and eliminating the need for suppliers to transport inventory to each individual Sysco warehouse. The company's second redistribution center became operational in April 2008^[13] and the company will evaluate the location of the remaining redistribution centers in the future.^[11] Sysco's national transportation management initiative will introduce a new system which will allow managers to view inbound freight as a network and not as individual shipments which will allow the company to consolidate inbound shipments. The company implemented the initiative in fiscal 2008 and will continue to improve upon it in fiscal 2009.^[11] The final initiative is the national implementation of demand planning and inventory management software. The company introduced this software in several regions in fiscal 2008 and will expand its use to more regions in fiscal 2009.^[11]

Quarterly Earnings

Q3 2009

In the third quarter of 2009, Sysco posted revenues of $8.74 billion, a 4.5% decrease from Q3 2008 figures; net income fell 6.1% to $226 million.^[14] The decrease in revenues is attributable to the worsening economy as consumers begin eating at home more often in an effort to save money. Sysco does not expect conditions to improve in the fourth quarter and plan for sales volumes to fall again.^[15] Although sales have decreased, product cost inflation has rapidly slowed, dropping to 3.3% in Q3 2009 from 6% the year before.^[16] Additionally, Sysco has started to benefit from its strategic initiatives, as they contributed to a 6.5% drop in operating expenses during the quarter.^[17]

Q4 2009

In the fourth quarter of 2009, Sysco posted revenues of $9.09 billion, a 7% decrease from Q4 2008 figures; net income fell 5.6% to $315.3 million.^[18] As in the previous quarter, revenues fell due a a decrease in demand as the recession continues to take its toll on restaurants and other food service establishments across the US. Sysco was benefited by slight deflation in its cost of goods sold, and commodities have retreated from their summer 2008 highs. Net income was also helped by a 6% reduction in workforce as well as a reduction in bonuses and other nonsalary items.^[18]

Q1 2010

In the first quarter of 2010, Sysco's revenues were $9.08 billion, a decrease of 8.1% from the previous year; net income rose 17.8% to $326.2 million. Operating income decreased by 1.5% to $497.3 million.^[19] The decline in revenue was primarily a result of lower product selling prices coupled with decreased consumer spending as a result of the recession. The difference in net income is the effect of an effective tax rate decrease from 42.5% in Q1 2009 to 29.9% in Q1 2010. The company also received a one-time tax benefit of $29 million relating to the reversal of interest accrued during a previous settlement with the IRS.^[20] Broadline, the company's largest segment which distributes supplies to restaurants, saw revenues decrease 7.2% from the previous year, keeping with the trend of the previous two quarters as fewer people are eating at restaurants thus keeping demand low.^[21] The company was able to reduce operating costs by $132 million from Q1 2009 due to lower payroll costs, having reduced their staff by 5% since last year.^[22]

Q2 2010

In the second quarter of 2010, Sysco's revenues were $8.87 billion, a decrease of 3.1% from the previous year, net earnings rose 12.9% to $268.3 million. Operating income increased 9.6% to $462.35 million.^[23] The primary reason for the decrease in revenues was a decrease in product selling prices as a result of 3.5% price deflation. This deflation is measured as the estimated change in the cost of products bought and was driven by deflation for dairy and beef products.^[24] Lower consumer spending and decreased restaurant traffic also played a large role in depressing revenues, as revenues for the Broadline segment, accounting for nearly 92% of all revenues decreased by 1.7% from Q2 2009.^[25]

Operating Segments

• Broadline (79.4% of revenue, 103.1% of operating income)^[26]: The Broadline segment distributes a full line of food products and a wide variety of non-food products to both traditional and small chain restaurant customers.^[26] This segment has higher profit margins than the rest of Sysco's operations as the result of better purchasing power, greater amount of capital expenditures, and a larger sales force. In fiscal 2008, the Broadline segment posted $1.85 billion in operating income on revenues of $29.8 billion.^[9] Since central corporate expenses are reported separately, Broadline's operating income was actually greater than total operating income.
• SYGMA (12.2% of revenue, 0.4% of operating income)^[26]: Sygma has the lowest margins of Sysco's operating segments because the fast food industry it serves typically has the lowest margins in the entire food service industry and makes its profits through volume of sales. The segment's largest customer is Wendy's International (WEN), making up 34% of total Sygma sales.^[6] Sygma's fiscal 2008 performance was negatively impacted by a a $5.6 million write down in software development costs and a decrease in sales volume due to weakness in the fast food industry and the consumer spending slowdown.^[27] In fiscal 2008, the Sygma segment posted $717,000 in operating income on revenues of $4.6 billion.^[9] The Sygma segment distributes a full line of food products and a wide variety of non-food products to certain chain restaurant customer locations and bills customers on a per-case-delivered basis.^[27]
• Other (9.7% of revenue, 7.3% of operating income)^[26]: The Other segment consists of Sysco's specialty produce, custom-cut meat, lodging industry products and international distribution companies.^[27] The companies in this segment are recent acquisitions that operate in a niche in the food service industry. Their revenues are smaller than those of companies in the Broadline segment, but Sysco may integrate the Other companies into Broadline companies in the future. In fiscal 2008, the Other segment posted $130.8 million in operating income on revenues of $3.6 billion.^[9]

Trends and Risk Factors

Increasing Fuel Costs Can Lower Demand and Increase Costs

Increased Efficiency Increases Productivity and Revenues

The company has focused on route efficiency, resulting in a fuel use decrease of 8% in early fiscal 2008.^[29] This trend continued through 2009, as diesel use decreased 7% while mileage decreased only 5%.^[30] Addtionally, the company has improved warehouse productivity by investing in new jacks which allow workers to increase the number of pallets they can carry at a time.^[28] Further investments in warehouse capital will allow the company to increase output without raising labor costs.

Sysco's Sales Affected by Consumers' Response to the Economic Slowdown

Sysco benefits from the expansion of casual dining - its core customer base. As the financial crisis spreads and consumers reduce their spending, they will trade down to eating at home instead of going out to restaurants. In November 2008, the percentage of American households serving leftovers increased to 57% from a historic average of 55%. Additionally, in the year ended February 2008, the average American worker took 42 home made meals to work, the most since 1995.^[31] A recession in the casual dining industry will hurt Sysco as its customers will order less products and go out of business.

Competition

Sysco is the largest food distributor in the United States with a 16% share of the $231 billion US and Canadian food service market.^[32] The company faces competitive pressure from two main sources.

• U.S. Foodservice is the second largest food distributor in the United States with an 8.6% share of the US and Canadian food service market.^[33] In 2007, the company was acquired by the private equity firms Kohlberg Kravis Roberts and Clayton, Dubilier & Rice.

• Performance Food Group Company is the third largest food distributor in the United States with a 2.7% share of the US and Canadian food service market.^[34] In 2008, the company was taken private by private equity firms The Blackstone Group and Wellspring Capital Management.

^{[33][34][9][35]}

References

1. ↑ SYY 2008 10-K pg. 38  
2. ↑ The Kitchen and Beyond.
3. ↑ SYY 2008 10-K pg. 1  
4. ↑ SYY 2008 10-K pg. 4  
5. ↑ Sysco buys Irish foodservice distributor.
6. ↑ ^{6.0 6.1 6.2 6.3} SYY 2008 10-K pg. 2  
7. ↑ SYY 2008 10-K pg. 58  
8. ↑ ^{8.0 8.1 8.2} SYY 2008 10-K pg. 16  
9. ↑ ^{9.0 9.1 9.2 9.3 9.4} syy 2008 10-K pg. 11  
10. ↑ syy 2008 10-K pg. 15  
11. ↑ ^{11.0 11.1 11.2 11.3} syy 2008 10-K pg. 12  
12. ↑ syy 2006 10-K pg. 12  
13. ↑ Redistribution center ready to roll.
14. ↑ SYY 2009 10-K  
15. ↑ wSYY 2009 10-K  
16. ↑ SYY 2009 10-K  
17. ↑ SYY 2009 10-K  
18. ↑ ^{18.0 18.1} Sysco Q4 revenue falls on weak demand.
19. ↑ SYY Q1 2010 10-Q, p. 2
20. ↑ SYY Q1 2010 10-Q, p. 20-21
21. ↑ SYY Q1 2010 10-Q, p. 22
22. ↑ SYY Q1 2010 Earnings Call, Seeking Alpha
23. ↑ SYY Q2 2010 10-Q, p. 19
24. ↑ SYY Q2 2010 Earnings Call Transcript, Seeking Alpha, 2/2/10
25. ↑ SYY Q2 2010 10-Q, p. 26-27
26. ↑ ^{26.0 26.1 26.2 26.3}
27. ↑ ^{27.0 27.1 27.2} SYY 2008 10-K pg. 19  
28. ↑ ^{28.0 28.1} SYSCO Corporation F1Q09 (Qtr End 09/27/08) Earnings Call Transcript.
29. ↑ SYSCO Corporation F1Q09 (Qtr End 09/27/08) Earnings Call Transcript.
30. ↑ Sysco Corporation F4Q09 (Qtr End 06/27/2009) Earnings Call Transcript.
31. ↑ Campbell Beats Bear Market as Consumers Seek Out Soup.
32. ↑ SYY 2008 10-K pg. 3  
33. ↑ ^{33.0 33.1} U.S. Foodsevice, Inc..
34. ↑ ^{34.0 34.1} Performance Food Group Company.
35. ↑ SYY 2008 10-K pg. 8