Clash of the Food Service Distribution Titans

In this segment of Motley Fool's Industry Focus:Consumer Goods podcast, a listener asks us to discuss the revenues, profits, and market valuations of foods service distribution leaders Sysco Corporation (NYSE: SYY) and US Foods Holding Corp. (NYSE: USFD). We duly put on our analysis hats and also touch on the companies' broader business models in the video segment directly below.

A full transcript follows the video.

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This video was recorded on March 21, 2017.

Asit Sharma: Let me read, again, the second part of his question, which is, revenue versus net income. How important is this in establishing a base value? Let's read these figures as well. Sysco's trailing 12-month revenue is $54 billion. It made net income of $1 billion. That's about a 2% net profit margin. US Foods had, as Vince was saying, about $23 billion in revenue. It made a profit of $210 million. That's approximately a 1% net profit margin. Again, this goes back to my first question -- why do you want to buy these businesses? But, I do see, especially with US Foods, it's much smaller and it's mostly domestic, so there's probably some growth opportunity there.

Typically, when we look at net profit and want to talk about valuation, we consider earnings. Usually, that's just net income divided by total number of shares outstanding, you get earnings per share. Personally, I love the forward P/E ratio, the forward price to earnings ratio. Whenever I'm looking at an industry for the first time, or two companies for the first time, I'd like to know, based on what these companies are projected to make over the next year in earnings per share, how is the stock price in relation to those projected earnings? Many people prefer the trailing 12-month P/E ratio, which is a look backward. I like to look forward.

The other thing that I'm very keen on doing, I don't have a lot of depth in the foodservice industry, but I do in the grocery industry, and they're very similar -- as a whole, if you take all the companies that are in this basket, on average, so, think of companies like Aramark, which is a competitor to each of these two companies, what is the price to earnings forward ratio in the industry as a whole? I looked this up for food service just now in the S&P 500. The forward P/E ratio is about 19.6 times. So, we get down to, what is the forward P/E ratio of US Foods and Sysco? What are these ratios versus the industry? And according to Yardeni Research, that industry P/E ratio of 19.6 times, here's how it stacks up: Sysco trades at a forward P/E ratio of 21 times earnings, and US Foods trades at a forward ratio of 20 times earnings.

So, these companies are both priced right at the market within their industry. They're not too high, they're not too low. Which then throws more emphasis on that first measure we looked at, and as Vince was saying, "Hey, US Foods looks like it's comparatively undervalued versus its bigger competitor." This next step we've taken, David's second question, shows us that may be what we have to go on here, because neither one of these companies has tremendous operating leverage. I would go back, if I was interested in US Foods versus Sysco, I would read the management's discussion and analysis part of their 10-K annual report and see what the strategy is for the next year, see if there's operating leverage that they can then turn into higher earnings and move that forward P/E ratio a bit up.

Vincent Shen: Thanks, Asit. Something that you brought up, in terms of how similar this industry can be to the supermarkets that we have previously discussed on the show before, just an example of something these companies are trying to do to boost profitability, for example, when the margins are so tight -- both companies are developing in-house private brands with better margins that they can offer to customers. For US Foods, their private brands make up 33% of their organic sales from 2016.

Overall, looking at these two companies, things to watch, something to keep in mind for Sysco, for example, is, they actually recently had a pretty big deal, I think it was about $3 billion or so, for moving into the European market. Already the leader, I think, the market share numbers that I could find between Sysco and US Foods, about 16% and 8%, respectively for the North American markets. So, Sysco trying to branch out. So, there's big growth opportunity there for them. Also, on the Sysco side, after its acquisition of Brakes -- Sysco is a dividend aristocrat, they pay a 2.5% dividend yield, and have been paying that for over 30 years at this point, giving them that dividend aristocrat status. So, those are some other things to keep in mind. Otherwise, this is definitely what could be considered a more stable industry, the idea that you're always going to need food service distributors, companies like these, to supply the restaurants that we go to, to supply the leisure industry, the hotel industry. But finding the differences between them, that scale makes a big difference.

Asit Sharma has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.