SYSCO Corporation (NYSE:SYY) is the largest food distributor in the world. The company distributes food products to restaurants and stores throughout the US (including Alaska), Canada, Ireland, and Puerto Rico.
Sysco has a long corporate history. The company was founded in 1969 and has increased its dividend payments for 44 consecutive years.
Trian Fund Management recently became the largest shareholder of Sysco. Trian now owns 7.1% of Sysco. Here’s what Trian CEO (and famous activist investor) Nelson Peltz had to say about his stake in Sysco after gaining a seat on the company’s board:
“Sysco is a leader in its business, and we believe it is undervalued and has tremendous long-term potential. As Sysco’s largest shareholder with an approximate 7.1 percent ownership position, we welcome the opportunity to work constructively with the Board and management.”
Trian’s involvement and board seat will likely spur interest in the company among the other elite investors in our database, whose interest in the stock was waning during the second quarter. Of the 730 investment firms that we actively monitor, 29 of them reported long positions in Sysco as of June 30, down from 37 on March 31. The value of their aggregate holdings was fairly level however, even registering a slight uptick to $2.21 billion despite the stock losing over 4% during the second quarter, so the investors who remained in the stock were even more bullish than ever. That was partly spurred by Peltz’s new position of 10.22 million shares at that time, while Yacktman Asset Management held over 33.96 million shares.
Declining Competitive Advantage
There’s no question Sysco is in need of a managerial talent infusion. The company’s operating margins have been declining since 2010:
- Fiscal 2010 operating margin of 6.4%
- Fiscal 2011 operating margin of 5.9%
- Fiscal 2012 operating margin of 5.4%
- Fiscal 2013 operating margin of 4.9%
- Fiscal 2014 operating margin of 4.6%
- Fiscal 2015 operating margin of 4.8%
Operating margins grew 0.2 percentage points in fiscal 2015. Prior to fiscal 2015, operating margin declined every year since 2010.
Falling margins are a sign of a declining competitive advantage. It is likely that recent margin improvements are a result of sinking gas prices rather than structural improvements. Low gas prices mean lower transportation costs for Sysco – which raises margins.
The food distribution industry is slow changing. Restaurants will always need food supplies, after all. Due to the commoditized nature of Sysco’s services, competition is fierce. Sysco’s declining margins show strong competition in the food distribution industry.
The US Foods Merger
Sysco planned to return to growth and strengthen its competitive advantage by acquiring its largest rival – US Foods. Here’s what I wrote about the proposed transaction when I last covered Sysco:
“In late 2013, Sysco announced plans to merge with its largest competitor, US Foods… US Foods is the second largest food distribution company in the US. As a result, the combined company will have significantly more pricing power than either business had on its own. The combined business will also have a more robust supply chain, further enforcing Sysco’s current competitive advantages. The strategic rationale behind the acquisition is to give the combined business enough scale advantage to negate the negative trend in operating margin through economies of scale and return the company to margin expansion. The deal is a net positive for shareholders; there is one catch, the deal is facing regulatory scrutiny.”
Unfortunately for Sysco, the proposed merger did not go through. The Federal Trade Commission blocked the merger on the basis that the combined company would have too much market share in specific regions. Sysco now has to pay a total of $315 million in break-up fees since the merger was not completed.