Category: Dividend Stocks

Companies return profits to shareholders through two main channels, capital gains and income. A high dividend yield indicates that a company is returning a large amount of cash to shareholders relative to the value of the company. This allows investors to maximize their income received relative to their investment amount. The gross dividend is calculated from the net dividend amount paid to shareholders plus the value of any attached franking credits associated with those dividends. A fully franked dividend will have franking credits equal to 30% of the gross dividend value, which can, therefore, represent a significant source of additional value.

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Dividend Stocks

Streamlined Portfolio Should Continue to See Solid Demand as Apartments Recover

The company invests in metropolitan markets with solid demographic trends that allow the company to maintain high occupancies and pass along consistent rent increases. Demand for apartments depends on economic conditions in their markets like job growth, income growth, decreasing homeownership rates, high relative cost of single-family housing, and attractive urban centers. Apartment Income has significantly simplified and streamlined its portfolio and strategy over the past decade. 

While the company has decreased its portfolio from over 300 properties at the end of 2008 to 96 properties in the current portfolio, the company owns approximately the same number of assets over that time frame in the 8 markets it currently considers to be its core markets. The company’s exit from markets with lower growth prospects has increased the portfolio’s expected average growth. In 2020, Apartment Income spun off its development pipeline and lease-up portfolio into its own company so that the remaining company could focus on the highest-quality assets.

Financial Strength 

Apartment Income is in decent financial shape from a liquidity and a solvency perspective. Debt maturities in the near term should be manageable through a combination of refinancing, asset sale proceeds, and free cash flow. The company should be able to access the capital markets when acquisition and development opportunities arise. As a REIT, Apartment Income is required to pay out 90% of its income as dividends to shareholders, which limits its ability to retain its cash flow. However, the company’s current run-rate dividend is easily covered by the company’s cash flow from operating activities, providing Apartment Income plenty of flexibility to make capital allocation and investment decisions. 

Fair value estimate to $47.50 per share from $44 after incorporating second-quarter results and adjusting our near-term forecasts to account for a better-than-anticipated recovery from the pandemic. Our fair value estimate implies a 4.3% cap rate on our forward four-quarter net operating income forecast, 23 times multiple on our forward four-quarter funds from operations estimate, and 3.5% dividend yield based on a $1.64 annualized payout. Currently project $200 million of dispositions a year at an average cap rate of 5.75% and $100 million-$200 million of acquisitions at 5.25% cap rates as the company looks to recycle lower-quality assets to fund the acquisition of higher-quality assets. Apartment Income’s net asset value to be approximately $39 per share.

Bulls Say’s

  • Apartment Income’s diversified portfolio of mainly suburban and infill assets should see less impact from supply, which is more concentrated in urban, luxury markets.
  • Positive demographic and economic trends will fuel strong demand for apartment rentals, including the millennial generation, which is beginning to move to the suburbs but still lack the necessary capital to purchase a home.
  • While supply growth may be near a peak now, rising construction prices and higher lending standards will reduce construction starts and reduce supply growth in the future.

Company Profile 

Apartment Investment and Management Co. owns a portfolio of 96 apartment communities with over 26,000 units. The company focuses on owning large, high-quality properties in the urban and suburban submarkets of Boston, Denver, Los Angeles, Miami, Philadelphia, San Diego, San Francisco, and Washington, D.C.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks Expert Insights

Sydney Airport Flight Delayed to Fiscal 2022; FVE Maintained

Long distances between major cities in Australasia means flying is a preferred mode of travel. Despite a rival airport scheduled to open in 2026, we expect Sydney Airport to remain the favoured terminal for business and long-haul leisure travellers for the next decade. Revenue is about evenly sourced from aeronautical and other operations. Aeronautical fees are mostly on a per-passenger basis, with base charges negotiated with airlines every five years. Retail is the largest non-aeronautical contributor, accounting for about 23% of pre-COVID-19 revenue.

Duty-free and luxury shopping has threats, given the ability for e-commerce sites to offer lower prices than duty-free, and ESG risks given the reliance on tobacco and alcohol sales. However, in the long run, risks materialising in any particular sub-category should be offset by passenger growth boosting defensive categories such as food, car-rental, parking, souvenirs, and holiday items. Population and passenger growth should aid Sydney Airport as it can increasingly allocate slots away from domestic and toward international flights. International flights account for about 40% of passengers, but about 70% of passenger revenue. 

Financial Strength

Sydney Airport’s financial health is fair, with relatively defensive income offset by high debt. Net debt/EBITDA was a high 14 times in fiscal 2021, up from 7.2 in 2019. Our base case is that by fiscal 2023 debt/EBITDA will be back to a more sustainable level below 8 times, and declining, but under our bear scenario this would not occur until 2025 and would remain elevated over our 10-year discrete forecast period. Management acknowledged the high debt and took appropriate actions to reduce leverage, including cancelling distributions in 2020, delaying capital expenditure, securing additional bank facilities, and raising AUD 2 billion in equity in the September quarter of 2020.

Narrow-moat Sydney Airport’s half-year result showed potential, with domestic traffic recovering to 65% of April 2019 levels. This is negligible for our unchanged fair value estimate of AUD 7.85 per share. The key driver is our unchanged post-virus recovery and passenger growth estimates. An acquisition proposal from IFM was this week increased to AUD 8.45, up from 8.25, but was immediately rejected by Sydney Airport. The consortium’s valuation assumptions are unknown. Bulls on Sydney Airport appear to expect Chinese travellers, about 8% of Australia’s arrivals in 2019, will resume rapid growth as borders reopen.

While the long term is the key driver, the near term is relevant given Sydney Airport’s high debt load. Domestic travel volumes through Sydney Airport in the first half of fiscal 2021 improved on the coronavirus-impacted volumes of the second half of fiscal 2020, but domestic border restrictions have resulted in volumes falling significantly in July. A net debt to EBITDA ratio of 14 times is extreme and will be problematic if Australian international borders remain closed for years into the future. Further, the weighted average maturity of Sydney Airport’s portfolio of debt is about five years, and the group has AUD 500 million in cash and AUD 2.4 billion in undrawn banking facilities, more than enough to cover debt expiries in the next two years.

Bulls Say’s 

  • Sydney Airport’s convenience to the business district and coastal suburbs of Australia’s largest city makes it near impossible to replicate. Rising incomes in nearby nations, and Australia’s growing population bodes well for long-term passenger numbers.
  • A light regulatory regime is unlikely to become significantly more onerous.
  • Sydney Airport has spare landing slots, plus the ability to reallocate slots away from domestic and toward more lucrative long-haul international flights, as passenger traffic grows.

Company Profile 

Sydney Airport has a lease to operate the facility until 2097. As Australia’s busiest airport, it connects close to 100 international and domestic destinations, and handled more than 40 million passenger movements annually until COVID-19 border restrictions in 2020. Regulation is light, with airports setting charges and terms with airlines, and the regulator monitoring the aeronautical and car park operations to ensure reasonable pricing and service. Retail and property operations are free from regulatory oversight, though political and commercial pressure limits Sydney Airport from overly flexing its pricing muscle, particularly as the government owns the rival Western Sydney Airport, set to open in 2026.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Tapestry Closed F.Y.21 on Good Note with Attractive Shares

Handbags and some types of apparel have been selling well as economies in the U.S. and greater China have recovered. Tapestry has good momentum as it enters fiscal 2022, so it is expected to lift share fair value estimate of $43.50 by a mid-single-digit percentage. Tapestry is one of the few firms in the apparel and accessories space that is currently undervalued, especially after its share price slid 3% after the earnings report.

Against an easy comparison, Tapestry reported constant currency sales growth of 122% in the quarter, eclipsing 118% estimate. More importantly, its sales rose 7% as compared with 2019, with most of the growth attributable to Coach. As targeted by the Acceleration Program, the firm achieved the $200 million in gross expense savings in fiscal 2021 and expects to achieve $300 million in additional savings this year. 

Tapestry has reinstated its dividend as its business has rebounded nicely from the pandemic, and plans to resume share repurchases. It intends to pay a dividend of $1 per share in fiscal 2022. Capital allocation rating on Tapestry is Standard.

Company’s Future Outlook

Tapestry’s quarterly adjusted operating margin of 16.9% came in 40 basis points above 16.5% forecast. Tapestry guided to fiscal 2022 EPS of $3.30-$3.35 on $6.4 billion in sales. Tapestry’s outlook is achievable based on current momentum in the business. It is believed that Coach has the brand strength to hold recent pricing gains; this may be more difficult for Kate Spade and Stuart Weitzman. It also guided to $500 million in repurchases in fiscal 2022, which would be its most since before the 2017 Kate Spade deal. Tapestry may look for another large acquisition in the future. The firm’s new CEO, Scott Roe, has considerable experience with acquisitions. 

Company Profile

Coach, Kate Spade, and Stuart Weitzman are the fashion and accessory brands that comprise Tapestry INC (NYSE:TPR). The firm’s products are sold through about 1,500 company-operated stores, wholesale channels, and e-commerce in North America (62% of fiscal 2020 sales), Europe, Asia (32% of fiscal 2020 sales), and elsewhere. Coach (71% of fiscal 2020 sales) is best known for affordable luxury leather products. Kate Spade (23% of fiscal 2020 sales) is known for colorful patterns and graphics. Women’s handbags and accessories produced 68% of Tapestry’s sales in fiscal 2020. Stuart Weitzman, Tapestry’s smallest brand, generates nearly all (98%) of its revenue from women’s footwear.

 (Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Hanesbrands’ Investment Key Brands Under Its Full Potential Plan Support

While the COVID-19 crisis adversely affected 2020 results, we think Hanes’ share leadership in replenishment apparel categories puts it in better shape than some competitors. Hanes’ management forecasts Champion will reach $3 billion in global sales in 2024, up from about $2 billion this year, which we see as an achievable goal. It has already made progress in this area, having achieved a 15% increase in manufacturing output over the past three years. More than 70% of the more than 2 billion apparel units sold by the company each year are manufactured in its own plants or those of dedicated contractors. 

Financial Strength 

Hanes is saddled with heavy debt from its acquisition spree in 2013-18 and closed June 2021 with $3.7 billion in debt. However, the firm also had nearly $700 million in cash and no borrowings under its revolving credit facilities of just over $1 billion. Moreover, we estimate Hanes will receive about $400 million in cash after it sells its European innerwear operations (expected in 2021). Hanes has a stated goal of bringing debt/EBITDA below 3 times by 2024, which we forecast may happen as early as the end of 2022.Hanes has suspended its share buybacks due to the pandemic, but we expect it will resume repurchases on a large scale in 2022. 

The company bought back significant amounts of stock in 2016 and 2017 and repurchased $200 million in shares in early 2020 before the virus spread. Its annual dividend has been set at $0.60 per share since 2017, but we forecast it will raise in 2022 and in subsequent years. We estimate an average annual dividend payout ratio of 38% in 2022-30.Hanes may expand the business through acquisitions, although it has not made a major acquisition since 2018. 

Our 2024 sales estimates for innerwear and activewear are $3.0 billion and $1.9 billion, respectively, up from $2.7 billion and $1.7 billion this year. In the long term, we model annual organic innerwear growth rates of 2%-3%. Although long-term growth in domestic innerwear (45% of 2020 sales) is low, Hanes has been gaining share in some basics categories. Our fair value estimate assumes moderate inflation in wage and cotton prices, resulting in a gross margin that stabilizes at 40%.

Bulls Say’s 

  • Hanes’ Champion is a contender in the hot but crowded athleisure space. The brand is already well known in North America and parts of Europe, and there is significant potential in China and other underpenetrated markets.
  • Hanesbrands has successfully introduced brand extensions that have allowed it to expand shelf space and increase price points in the typically staid category of basic apparel.
  • After a review, Hanesbrands announced a new strategic plan called Full Potential to boost growth and reduce expenses, which should benefit its brand strength.

Company Profile 

Hanesbrands manufactures basic and athletic apparel under brands including Hanes, Champion, Playtex, Bali, and Bonds. The company sells wholesale to discount, midmarket, and department store retailers as well as direct to consumers. Hanesbrands is vertically integrated as it produces more than 70% of its products in company-controlled factories in more than three dozen nations. Hanesbrands distributes products in the Americas, Europe, and Asia-Pacific. The company was founded in 1901 and is based in Winston-Salem, North Carolina.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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ASX Interest Rate Pressures to Abate From Economic 2023

with the wide economic moat protecting strong margins and enabling returns on invested capital to exceed the weighted average cost of capital. The capital-light business model and a lack of desire to undertake acquisitions should enable strong cash conversion, a 90% dividend payout ratio, and a debt-free balance sheet. The yield nature of the stock means we expect the share price to be largely driven by bond market movements and central bank interest rates. The ASX has long been protected by two significant barriers to competition through regulation and network effects. 

The federal government and regulators have sought to increase competition for nearly a decade, but the process of regulatory reform is slow and still has many obstacles to overcome. In March 2016, the government reiterated its desire for competition in cash equities clearing, which constitutes just 7% of ASX group revenue, but not in cash equities settlements, which make up a further 6% of group revenue. There are currently no proposals to introduce competition in derivatives clearing, ASX’s largest business (comprising around a third of group revenue), with obstacles such as cross-margining acting as a barrier to competition.

Financial Strength 

ASX is in good financial health due to its dominant Australian securities exchange, high margins, and capital-light business model. The wide economic moat has protected consistently strong and stable EBIT margins of around 70% over the past decade, and we forecast an average EBIT margin of around 70% over the next five years. Although revenue is vulnerable to market declines to some degree, the large margins limit leverage at an EPS level. 

ASX lacks an appetite for acquisitions, which is not a bad thing in our opinion. The company seeks to drive growth organically through product innovation and cost efficiencies. Our fair value estimate excludes the value of ASX’s franking credits, which are received by Australian resident taxpayers. However, as discussed in our recent special report, “10 Franked Income Stock Ideas for Australian Investors,” franking credits can effectively boost the fair value estimate for investors that receive them. 

Revenue was 4% above our forecast due to stronger than expected performances from the cash equities, listings, and information services divisions, but a weaker-than-expected performance from the derivatives and OTC division. Our fiscal 2022 expenses growth forecast of 5% is at the lower end of management’s guidance range of 5% to 7%, and lower than the 8% reported for fiscal 2021. Our fiscal 2022 capital expenditure forecast of AUD 114 million is at the top end of the AUD 105 million to AUD 115 million guidance range, and lower than the AUD 125 million in fiscal 2021.

Bulls Say’s 

  • Long-term earnings growth is underpinned by growth in the value of the stock market and protected by a wide economic moat. However, in the short term, earnings can be affected by market weakness, although EPS fell just 7% during the global financial crisis.
  • ASX has a wide economic moat underpinned by network effects and regulation. We expect this competitive advantage to protect EBIT margins of around 70% over the next decade and a low-single digit EPS CAGR.
  • ASX is financially robust with a good balance sheet, strong cash flow, and tight cost control.

Company Profile 

ASX is the largest securities exchange in Australia with an effective monopoly in listing, trading, clearing, and settlement of Australian cash equities, debt securities, investment funds, and derivatives. Other activities include the technology services, enforcing exchange rules, and exchange-related data. The ASX demutualised and listed on its own exchange in 1998 and subsequently acquired the Sydney Futures Exchange in 2006.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Treasury Lacks an Economic Moat Amid the Highly Competitive and Volatile

particularly in luxury (bottles priced above AUD 20) and “masstige” (bottles priced from AUD 10 to AUD 20) wine. With this focus, the company’s revenue from higher-end wines has risen to over 70% in fiscal 2021 from 43% in early 2014, both from growth in its high-end products and purposeful reduction of low-end, or commercial, wine sales. We expect continued end-market premiumisation to benefit Treasury, leading to market share gains in Australasia and North America, which together made nearly half of operating earnings in fiscal 2020

However, Treasury will face an installation of a sizable tariff against its imported product in China in fiscal 2021, effectively shutting the door in what was arguably Treasury’s most important market, comprising 30% of earnings in fiscal 2020. The company plans to reallocate some of this wine to other markets, but the associated sales and marketing efforts will take time, reducing growth from previous expectations. Treasury also faces risks from unfavourable weather effects, sensitivity to the consumer cycle, and inelastic industry supply that frequently results in wine gluts or shortages. But the diversity of Treasury’s grape and bulk wine supply should significantly mitigate these concerns.

The reason why Treasury lacks an economic moat:

  • Treasury Wine Estates has not carved out an economic moat, in our opinion. Although we expect the firm’s strategic shift to focus on high-end wines and its increased geographic diversification to benefit both long-term top-line growth and profitability, the wine industry’s high degree of competition, and volatile annual demand will likely limit Treasury’s ability to generate sustainable excess economic profits. These concerns are further exacerbated by persistent industry oversupply and specific taxation rules in Australia that award excise tax exemptions against the first AUD 350,000 in direct-to-consumer sales, a barrier to industry consolidation. Furthermore there is also continued pressure from powerful retailers in Australia, where liquor stores owned by grocery giants Woolworths and Coles account for over 50% of total wine sales and
  • We don’t believe owning a portfolio of wine brands builds a moat worthy intangible asset because wine brands are stand-alone assets and therefore consumer awareness of Treasury’s ownership in both Stags’ Leap and Berringer in the U.S., or Penfolds and St Huberts in Australia, leads to improved pricing for the respective brands versus peers, or if such awareness even materially exists. There are some cost benefits to running a portfolio of wine brands, as Treasury can optimise its grape sourcing and production within its many geographies. But we expect premium wines will likely continue to see fluctuations in supply and fruit cost year to year.
  • In all, despite the positives of premiumisation in recent years, ROICs considerably trailed WACC until fiscal 2019. This is due to the substantial inventory requirements of wine-making, the high cost of land ownership, difficult price competition in a very fragmented market, and Treasury’s lack of scale economies and brand intangible assets versus larger peers.

Bulls Say

  • Wine consumption growth in Asia should continue growing at high rates over the long run, and is a high margin business for Treasury given a focus on luxury and mid-range wine.
  • Treasury’s focus on higher-priced wine than in the past puts the company on-trend in global wine, and should drive substantial earnings growth as profitability expands.
  • Additions of new high-end wine brands, either organically or through acquisition, drive better grape utilisation, improving margins, and higher ROICs.

Company Profile

Treasury Wine Estates is an Australia-based global wine company that demerged from Foster’s Group in 2011. The company is among the world’s top five wine producers, and owns a portfolio that includes Australian labels such as Penfolds and Wolf Blass, U.S. wines like Chateau St Jean and Sterling, and newly launched names such as 19 Crimes and Maison de Grand Esprit. An acquisition of Diageo’s wine business in 2016 added additional U.S. brands including BV and Stags’ Leap. Treasury owns over 130 wineries, with more than 13,000 planted hectares.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Dividend Stocks

Bendigo & Adelaide Bank (ASX: BEN) Updates

  • Strong franchise model with funding predominately by way of deposits.
  • Expected low levels of impairment charges (especially as a low interest rate environment helps customers and arrears).
  • Continued strong cost discipline, improving efficiency and boosting performance. 
  • Advanced accreditation in progress (which may improve ROE).
  • Potential pressure on net interest margins as competition intensifies, with major banks in a low interest rate environment.
  • Leading in terms of customer satisfaction and net promoter metrics, which are increasingly key in a period where trust is paramount.

Key Risks

  • Intense competition for loan growth, combined with further discounting.
  • Volatility in Home safe earnings.
  • Increase in bad and doubtful debts or increase in provisioning. We continue to monitor the asset quality of Rural Bank and Great Southern portfolios.
  • Funding pressure for deposits and wholesale funding.

FY21 Results Summary

Relative to the PCP: Statutory net profit of $524.0m was up +172%.  Cash earnings after tax of $457.2m, was up +51.5%.  Net interest margin of 2.26%, was down 7 bps. Total income on a cash basis of $1,702.5m, was up +4.5%, with BEN exceeding system lending growth. Bad and doubtful debts were $18.0m, which equates to 2bps of gross loans. 

Excluding the provision release of $19.4m announced on 5 August 2021, bad and doubtful debts equate to 5bps of gross loans. Operating expenses of $1,027.4m were up +0.6% over the PCP, on increased investment in transformation. Excluding transformation, operating costs were -2.5% lower. BEN’s cost to income ratio of 60.3% was down 240bps relative to the PCP, but remains above BEN’s medium target of a sustainable cost to income ratio 50%. CET 1 of 9.57% was up 32 bps, and remains above APRA’s ‘unquestionably strong’ benchmark.  Cash earnings per share were 85.6 cents per share (cps), up +43.4%.

 The Board declared a final dividend of 26.5cps which brings the total fully franked dividend of 50.0 cps for the full year, with DRP discount of 1.5%. The dividend payment equates to 58.4% of cash earnings.  BEN saw growth in market share in lending (up to 2.41% from 2.24% in FY20) and deposits with total lending of $72.2bn, up +10.6%, driven by residential lending (at a rate of 2.8x system or up +14.8%), and total deposits of $78.0bn, up +15.2%, with customer deposits up +14.2%

Company Description

Bendigo and Adelaide Bank Ltd (BEN) offers a variety of banking and other financial services including internet banking, housing finance, retail and business banking, commercial finance, funds management, treasury and foreign exchange services, superannuation and trustee services.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Charter Hall Retail REIT Looks Defensive; Shares Fairly Valued

But we maintain our long-term assumptions and AUD 3.85 fair value estimate, which sees the stock screen as fairly valued. The REIT announced a final distribution of AUD 12.70 cents per security, taking full year distributions to AUD 23.40 cps. As a result of recent restrictions, the New South Wales and Victorian governments have reimplemented a landlord code of conduct similar to that enforced in 2020. The scheme forces landlords to provide rent waivers and deferrals for small to medium enterprises where turnover has been curtailed due to restrictions. This is likely to push more consumers to online shopping channels, fuelling the ecommerce trend.

While the near-term impact hurts especially with lockdowns potentially lasting late into calendar 2021 in line with the current vaccine rollout pace, the overall impact on Charter Hall Retail should be contained, relative to the impact in 2020. Its portfolio is increasingly dominated by major longleased tenants that are not eligible to defer rents under the government schemes. Also, the REIT has made significant efforts to increase omnichannel capabilities for tenants including click and collect facilities. This should reduce the financial impact on stores and thus reduce the need to waive or defer rent.

Company’s Future Outlook 

We forecast operating earnings per share to increase by 5% to AUD 28.60 per security in fiscal 2022, underpinned by a 2% increase in rental growth. We don’t expect there to be another equity raising, even in an extended lockdown, after one in 2020. Overall Balance sheet gearing looks modest at 33%, which sits at the midpoint of the target range of 30% to 40%. We view 55% of the REIT’s tenants as defensive (unlikely to miss a rent payment), which include the likes of Woolworths, Coles, bp, Wesfarmers, and Aldi. Supermarkets and service stations are also less likely to be impacted by COVID-19 restrictions. The proportion of portfolio income that these major tenants contribute to has steadily increased over the years, with the top five listed above representative of 54% of the portfolio income, up from 51% in fiscal 2020.

Company Profile 

Charter Hall Retail REIT, or CQR, owns and manages a portfolio of convenience focused retail properties, including neighbourhood and subregional shopping centres, service stations, and some retail logistics properties. The REIT is managed by Charter Hall, a listed, diversified fund manager and developer, which owns a minority stake in CQR, and frequently partners with it on acquisitions and developments. More than half of rental income comes from major tenants Woolworths, Coles, Wesfarmers, Aldi and BP (the latter occupies service station assets). The portfolio is more seasoned than some convenience rivals, with approximately two thirds of supermarket tenants at or near thresholds for paying turnover-linked rent.

(Source: Morningstar)

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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U.S. Foods Experiencing Strong Recovery From the Pandemic, but Moat Remains Out of Reach

will emerge from the pandemic in a stronger position that it was prior to the crisis, given the $1 billion in new business secured over the past year and the permanent elimination of $130 million in operating expenses. We expect the increasing availability of COVID-19 vaccines in 2021 will return US Foods’ organic sales to pre-pandemic levels by 2022, with long-term opportunities remaining intact. But as US Foods has not demonstrated a cost advantage, organic market share gains , consistent economic returns, or superior profits, we do not grant the firm a moat.

US Foods has improved profits the past few years, as gross margins increased from 16.8% in 2014 to 17.8% in 2019 (pre-pandemic), operating margins from 2.0% to 3.2%, and ROICs .We attribute this to positive customer mix (both to more profitable segments and more selective customer contracts within segments), more effective data-driven pricing, the centralization of purchasing and administrative functions, and a reduction of the sales force, facilitated by productivity-enhancing tools. But despite the added profits, we believe the reduction in the sales force hampered organic market share gains, a move with nontrivial consequences, as we view scale as the path to a competitive edge.

The lack of organic share gains impairs the firm’s ability to leverage its scale and progress toward a scale-based cost advantage. But we are encouraged by the firm’s recent decision to invest $50 million in growth opportunities, including expanding the sales force. We expect the firm will continue to grow inorganically, and we have a favourable view of its $1.8 billion tie-up with SGA Food Group and the $970 million acquisition of Smart Foodservice Warehouse, but we hold these deals fall short of providing a scale-based competitive edge.

Financial Strength

 US Foods has the financial strength to weather the pandemic. Given the firm’s acquisitive strategy, leverage runs high, with net debt/adjusted EBITDA at 5.4 times as of June. US Foods secured a $300 million term loan, issued $1 billion in long-term notes, and $500 million in convertible preferred stock since the onset of the pandemic. We expect leverage to return to a comfortable 2.6 times by 2023 as the market recovers from the pandemic and US Foods lightens up on share repurchases to prioritize debt reduction, which we think is prudent. We expect US Foods will resume repurchasing shares in 2025 (to the tune of 4%-5% of shares outstanding annually). We view this as a prudent use of cash when shares trade below our assessment of its intrinsic value. Furthermore, we have no concerns in the firm’s ability to service its debt (even during the pandemic), as interest coverage (EBITDA/interest expense) should average 6.5 times over the next five years, better than the 4.4 times average over the past three years. The firm’s priorities for cash use are capital expenditures, which we expect to amount to 1% of revenue annually over the next decade) and acquisitions (we expect about $140 million to $220 million annually, contributing a 1% bump to revenue each year). Further, the firm paid a $3.94 per share special dividend in 2016, but management has no plans to initiate an ongoing dividend as they view share repurchase as a more flexible way to return capital to shareholders. 

Bull Says

  • Continued acquisitions could modestly enhance US Foods’ scale, and the addition of its e-commerce platform should help increase share of wallet and loyalty with acquired firms’ customers.
  • US Foods is emerging from the pandemic as a stronger player, having secured over $1 billion in new business and eliminated $130 million in fixed costs.
  • US Foods benefits from secular tailwinds, such as Americans’ tendency to consume more food outside the home and industry share shifts to independent restaurants.

Company Profile

US Foods is the second-largest U.S. food-service distributor behind Sysco, holding 10% market share of the highly fragmented food-service distribution industry. US Foods distributes more than 400,000 food and non-food products to the healthcare and hospitality industries (each about 16.5% of sales), independent restaurants (33%), national restaurant chains (22%), education and government facilities (8%), and grocers (4%). In addition to its delivery business, the firm has 80 cash and carry stores under the Chef’Store banner .After Sysco’s attempt to purchase US Foods failed to gain federal approval in 2015, US Foods entered the public market via an initial public offering.

(Source: Morningstar)

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Narrow-Moat Sysco’s Recipe for Growth Is Cooking up Improved Performance

the food-service market has nearly fully recovered, with sales at 95% of prepandemic levels as of the summer of 2021, and Sysco has emerged as a stronger player, with $2 billion in new national account contracts (3% of prepandemic sales) and 13,000 new independent restaurant customers. The plan should allow Sysco to grow 1.5 times faster than the overall food-service market by fiscal 2024. Sysco is investing to eliminate customer pain points by removing customer minimum order sizes while maintaining delivery frequency and lengthening payment terms. It improved its CRM tool, which now uses data analytics to enhance prospecting, rolled out new sales incentives and sales leadership, and is launching an automated pricing tool, which should sharpen its competitive pricing while freeing up time for sales reps to pursue more value-added activities, such as securing new business.

Further, Sysco has switched to a team-based sales approach, with product specialists that should help drive increased adoption of Sysco’s specialized product categories such as produce, fresh meats, and seafood. Lastly, Sysco is launching teams that specialize in various cuisines (Italian, Asian, Mexican) that should drive market share gains in ethnic restaurants. Looking abroad, Sysco has a new leadership team in place for its international operations, increasing our confidence that execution will improve.

Financial Strength 

Sysco’s solid balance sheet, with $5 billion of cash and available liquidity (as of June) relative to $11 billion in total debt, positions the firm well to endure the pandemic. Sysco has a consistent track record of annual dividend increases (even during the 2008-09 recession), and in May 2021 it announced an increase in its dividend, taking the annual rate to $1.88. Sysco has historically operated with low leverage, generally reporting net debt/adjusted EBITDA of less than 2 times. Leverage increased to 2.3 times after the fiscal 2017 $3.1 billion Brakes acquisition, and to 3.7 times in fiscal 2021, given the pandemic. But we expect leverage will fall back below 2 by fiscal 2023, given debt paydown and recovering EBITDA.

In May 2021, Sysco shifted its priorities for cash in order to support its new Recipe for Growth strategy. It’s new priorities are capital expenditures, acquisitions, debt reduction when leverage is above 2 times, dividends, and opportunistic share repurchase. Its previous priorities were capital expenditures, dividend growth, acquisitions, debt reduction, and share repurchases. In fiscal 2022-2024, as it invests to support accelerated growth, Sysco should spend 1.3%-1.4% of revenue on capital expenditures (falling to 1.1% thereafter). 

Bulls Say’s 

  • As Sysco’s competitive advantage centers on its position as the low-cost leader, we think Sysco should be able to increase market share in its home turf over time.
  • Sysco has gained material market share during the pandemic, allowing it to emerge a stronger competitor.
  • Sysco’s overhead reduction programs should make it more efficient, enabling it to price business more competitively, helping it to win new business, and further leverage its scale.

Company Profile 

Sysco is the largest U.S. food-service distributor, boasting 16% market share of the highly fragmented food-service distribution industry. Sysco distributes over 400,000 food and nonfood products to restaurants (62% of revenue), healthcare facilities (9%), travel and leisure (7%), retail (5%), education and government buildings (8%), and other locations (9%) where individuals consume away-from-home meals. In fiscal 2020, 81% of the firm’s revenue was U.S.-based, with 8% from Canada, 5% from the U.K., 2% from France, and 4% other.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.