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A driver for Sysco unloads supplies for a restaurant in Cleveland Tuesday, Dec. 21, 2010. (Mark Duncan/ASSOCIATED PRESS)
A driver for Sysco unloads supplies for a restaurant in Cleveland Tuesday, Dec. 21, 2010. (Mark Duncan/ASSOCIATED PRESS)

food service

Sysco's acquisition sends shares soaring, but be cautious Add to ...

Investors are devouring shares of Sysco Corp. as the largest food distribution company in North America grabs an even greater portion of the market through the $3.5-billion (U.S) acquisition of privately owned US Foods Inc.

Sysco stock touched a record high on Monday as buyers salivated over the scale and reach of the combined company and the potential savings the merger will produce. Together, the merged business will hold almost 30 per cent of the $235-billion Canada and U.S. food-service market – up from Sysco’s current 18-per-cent position – and pull in $65-billion in annual revenues, which analysts say is five times greater than the next-biggest player.

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In another positive for investors, the two private equity shareholders that own most of US Foods are demonstrating their confidence in the deal. Clayton, Dubilier & Rice LLC and Kohlberg Kravis Roberts & Co. LP are taking a 13-per-cent interest in the merged company, as well as seats on the board.

“They wouldn’t be doing that if they wanted to exit the business,” Morningstar Inc. analyst Erin Lash said in an interview. In a note, she called it one of the “most interesting and unusual aspects of the announcement.”

Some investors remain cautious on Sysco given the Houston-based company’s challenges, including increased competition from smaller companies and big-box stores. The company provides food and supplies to more than 400,000 customers from 193 distribution centres across North America, Ireland and the Bahamas. Higher fuel prices and a struggling restaurant sector have been drags on Sysco’s bottom line and it is rolling out a major restructuring to cuts costs.

The purchase of US Foods is “about improving productivity,” Sysco chief executive Bill DeLaney said during a conference call on Monday. He estimated the merger will be able to produce about $600-million a year in savings after three years.

The cash-and-stock deal, expected to close next fall, creates a company valued at $8.2-billion, including $4.7-billion in debt Sysco will take over from US Foods.

The offer values US Foods at nearly 10 times its trailing 12-month adjusted earnings before interest, taxes, depreciation, and amortization of $826-million, which Morningstar’s Ms. Lash said “seems fair to us.”

Still, she is cautious about predicting how successful the acquisition will be. “This deal is not without risks, and represents a shift from a management team that had been more measured in building out its network and taking on larger deals,” Ms. Lash noted.

Sysco has racked up about 150 mergers and acquisitions in its 40-year history – including the food service arm of Canadian grocery retailer Metro Richelieu Inc. last year – but none as “transformational” as the US Foods transaction, she said.

Cantor Fitzgerald analyst Ajay Jain believes the valuation for US Foods is “relatively rich” and was surprised by the stock’s surge on the news. “The US Foods acquisition is likely to have a negative effect on customer mix (which is already deteriorating and shifting to low-margin chain customers),” noted Mr. Jain, who has a “sell” on the stock.

Among the 13 analysts that cover Sysco stock, eight recommend it as a “hold,” four suggest “sell” and one calls it a “buy,” according to Thomson Reuters I/B/E/S.

Investors were bullish Monday, and in early trading on the New York Stock Exchance the stock jumped 26 per cent to a record high of $43.40. It closed up 10 per cent at $37.62.

Prior to Monday’s pop, Sysco stock had underperformed the market so far this year, rising 8 per cent compared to 27 per cent for the S&P 500.

A major lure for some shareholders is the company’s rich 3.5-per-cent dividend yield. Sysco said Monday it plans to keep the dividend, which it has paid every quarter since 1970, and increased 45 times since going public.

The company also said it intends to maintain its strong investment-grade rating. However, Moody’s Investors Service placed its ratings under review for possible downgrade, despite calling the price of US Foods “reasonable given synergy potential.”

Follow on Twitter: @BrendaBouw

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