Sysco (SYY) - Valuation Analysis

Description

Sysco Corporation (Sysco), along with its subsidiaries and divisions, is a North American distributor of food and related products primarily to the foodservice or food-away-from-home industry. The Company provides products and related services to approximately 400,000 customers, including restaurants, healthcare and educational facilities, lodging establishments and other foodservice customers. Sysco provides food and related products to the foodservice or food-away-from-home industry. The Company has aggregated its operating companies into a number of segments, of which only Broadline and SYGMA are the main segments. Broadline operating companies distribute a line of food products and a variety of non-food products to their customers. SYGMA operating companies distribute a line of food products and a variety of non-food products to chain restaurant customer locations.

The products the Company distributes include a line of frozen foods, such as meats, fully prepared entrees, fruits, vegetables and desserts; full line of canned and dry foods; fresh meats; dairy products; beverage products; imported specialties, and fresh produce. Sysco also supplies a variety of non-food items, including paper products, such as disposable napkins, plates and cups; tableware, such as china and silverware; cookware, such as pots, pans and utensils; restaurant and kitchen equipment and supplies, and cleaning supplies. No single customer accounted for 10% or more of Sysco’s total sales during fiscal 2010.

Source: Reuters

Valuation

I estimated the intrinsic value of SYY to be $33.62.  Key assumptions included:

                Core growth rate: 7.5%

                Terminal growth rate: 3.0%

                Risk-adjusted discount rate: 11.5%

                Cost of sales: 81.0%

                Selling, general, & administrative costs as % of sales: 14.0%

                Research & development as % of sales: 0.0%

                CAPEX as % of sales: 1.5%

                Depreciation as % of sales: 1.0%

                Effective tax rate: 38.0%

                Day sales in receivables: 26

                Day sales of inventory: 22

                Days payable outstanding: 24

Given the current market price of $31.29, SYY is undervalued by 6.9% to its intrinsic value, which is a positive.  The risk-adjusted margin of safety was calculated to be 15.5%.  Since the actual margin of safety (6.9%) is less than the risk-adjusted margin of safety (6.9%), SYY may not be appropriate to buy at this time.

Dividends

The dividend appears to be growing faster than earnings growth, but has slowed in recent years.  From 2000 to the 2010, the dividend has grown from $0.24 per share to $1.00 per share.  The compound annual growth rates for the past ten-, five-, and three-years are:

                Ten years: 17.2%

                Five years: 13.6%

                Three years: 9.6%

Although growing faster than earnings, the dividend appears to be sustainable.  Based on net income, the dividend payout ratio exceed 50% once.  Based on free cash flow, the dividend payout ratio has fluctuated more ranging from 47.2% to 199.4%.  A dividend payout ratio of less than 50% is a positive allowing for sustainable growth and a cushion for short-term earnings volatility.  Below is the dividend payout ratio for the past five years:

                2006: 46.5%

                2007: 44.5%

                2008: 45.0%

                2009: 51.9%

                2010: 49.1%

In the book, The Ultimate Dividend Playbook, Josh Peters discusses a model to calculate a stock’s prospective return.  The model is called the Dividend Drill Return Model (DDRM).  It is based on the premise that the dividend total return is equal to the yield plus dividend growth.  Dividend growth is then broken into core growth (the rate of growth for total profits) plus share change (reduction of shares due to share repurchase). 

Given a core growth rate of 7.5% and current dividend yield of 3.3%, SYY’s cost of growth is $0.48 per share.  After reducing this amount and dividends of $1.04 per share, the funding surplus is $0.47.  SYY can use this $0.47 per share to reduce outstanding shares; this amount is forecasted to have a 1.5% impact on share price.  As a result, the DDRM forecasts the projected total return for UTX to be 12.3%.  Below is a breakdown of the total return:

                Core growth rate: 7.5%

                Dividend yield: 3.3%

                Funding surplus: 1.5%

                Total return: 12.3%

Summary

Based on a valuation $33.62, shares are trading at a 6.9% discount to the intrinsic value.  Given a risk-adjusted margin of safety of 15.5%, SYY could be considered a buy at $28.40.  SYY has a history of dividend increases and the dividend appears sustainable as the payout ratio is around 50%.  Based on the DDRM, the projected total return for SYY is 12.3%.