Jeremy Glaser: I'm Jeremy Glaser for Morningstar.com. With interest rates so low, a lot of investors are looking for yields in a bunch of different places. One good idea could be Sysco. Here to dive into it a little bit deeper is editor of Morningstar DividendInvestor, Josh Peters.
Josh, thanks for joining me today.
Josh Peters: Happy to be here.
Glaser: A lot of times you've talked about the three questions that you have to ask for any dividend-paying stock. Can we talk a little bit about Sysco and how you would answer your three questions for this one?
Peters: Yeah. My process really tries to take the whole mass of information that an investor has to consider about a particular company, and narrow it down to just three questions that are relatively easy to at least think about. Not always easy to answer, but easy to think about.
First of all, assuming that the dividend yield is a meaningful component of your total return--let's say 2% or more--then a lot of the situation is going to come right down to the dividend.
The first question I want to know is, is this dividend safe? Or is something that's going to go away in the next recession, or the next time the company has a kind of short-term problem?
The second question is will this dividend grow? If I want to own a dividend, I also want it to grow at least as fast as inflation. I don't want to lose the purchasing power of my income. And I want that rising dividend to really help drive the stock price up, too, so I'm earning a good total return, not just the dividend.
And then if I consider both the income yield component that comes out of the "is it safe" question, and the income growth component, now I get some sense of what the total return of this stock is going to be going forward, so the question becomes is this enough? Does the total return picture make sense?Read Full Transcript
Glaser: So if we look at Sysco in particular, what about it attracts you to the stock? Can you give us a short description of the business and why you like it?
Peters: I've owned Sysco for several years now, and some of the factors I've found attractive is it's got a good above-average dividend yield. The market overall yields only about 2% right now. Sysco has had a yield of 2.5% to as much as 4%, at some points over the last couple of years.
Another is, we think Sysco has a wide economic moat. If you're in a distribution business, the number of customers--how dense your customer base is--can become a real competitive advantage. Because you can run the same trucks making deliveries over a small area from a central warehouse, as opposed to a competitor who might have one warehouse serving a much larger area, much more expensive.
Sysco has three times the market share of its next largest competitor, and that means their costs are low, and we think sustainably low relative to rivals.
And another thing that I like is that the company has done a good job of allocating capital over the long run. Providing dividends, but also providing a lot of growth. And even though their business is distributing food service and other sorts of products mostly to restaurants--which is kind of a cyclical area of the economy--the company has really done quite well navigating through this recession.
Profitability remains pretty high. It's really been more of an absence of growth as opposed to a big fall-off in profits. It's got a lot of the basic defensive characteristics that I look for in a dividend-paying stock.
Glaser: Let's move to the first question then. Is Sysco's dividend safe?
Peters: I think so. I certainly wouldn't own or recommend the stock if I thought it wasn't safe. But I think this is a good example to talk about some of the factors that I would consider.
Depending on the kind of business, you might have to consider all sorts of aspects of the company financially. But a good starting place is to look at the company's payout ratio. This is the dividend divided by earnings, and it shows you what percentage of earnings are being used to pay out the dividend.
The way I like to calculate this is actually take the Wall Street consensus estimate. For all its shortcomings, it is a relatively clean and forward-looking figure, even if we know it's probably going to be off by some range of error. And divide that into the current dividend.
In the case of Sysco, they're paying out about 52% or 53% of this year's profits. Now good starting point, certainly, but is that a good level?
Typically for businesses that are not, say, utilities or pipelines that structurally have very high payout ratios, I look at anything under 60% as generally being reliable. But for a business as steady as Sysco's has been, I think that's actually very reliable figure.
Some other figures I would look at is to look at cash flow. How much is the company collecting from operations, where is that money going? You look out over the last three years, the total cash flow from operations has been $4.6 billion.
$1.6 billion has gone back into the business for capital spending, that leaves a free cash flow of $3 billion. Of that $3 billion, half of it has gone out at as dividends. So this shows that you've got very good cash flow coverage for the dividend, not just on an earnings basis.
Then finally, you also want to look at debt in almost any situation. Sysco does have some long-term debt, but it's a very low ratio relative to the company's profitability. If you look at operating income divided by interest expense, Sysco is covering that interest expense 16 times over. There's really no doubt of their ability to pay the Visa bill, so to speak.
Glaser: If we look at the second question, then, does this dividend look poised to grow?
Peters: Sysco has a terrific growth record. It's raised its dividend every year since the company came public back in the 1970s. That's a pretty rare record. And even over the last two years, the company continues to raise it dividend.
So I don't doubt the willingness of the company to go on raising the dividend, which is a very important point. You don't just want to do the math and say, "Well, they can, therefore they will." You want to see that willingness established.
Something that's perhaps not quite as favorable about the Sysco story is the growth rate has come down a bit. Over the last five years, Sysco's dividend has risen by an average of more than 12% a year. Last year, that dividend only went up 4%. Or actually it went up 4% for 2010.
So growth rates come down. Now you want to think in terms of where does it go from here? The way I like to break it down is how fast can the company grow internally, which is really a function for Sysco of food price inflation and the state of its restaurant customers.
You figure this is about a 4% or 5% growth business over the long run. There's going to be some cyclical aspects to it. But most of that really is just inflation. So there's not a whole lot of big growth expectations baked in here.
But that's only part of the story. If total cash flow is growing 4% or 5%, but they're only paying out half of that after capital spending, you've still got this pot of money that's available every year to also benefit shareholders.
And in the case of Sysco it could go to share buybacks, it could go to acquisitions. Overall, this probably adds another 3% to 4% to the company's growth rate on a per-share basis. So I wind up with an overall growth estimate that looks for 7% to 9% a year on average over the long run. Not as good as the last five years, but still a pretty good rate of growth.
Glaser: At today's prices, does the total return picture make sense?
Peters: I think it's in the ballpark. I'd certainly characterize Sysco as a good hold at this level, trading at about $28. In order to buy, I would hold out for, I think, a little bit lower, about $27.
I really look at the situation two ways. One is, what is the dividend yield plus that growth component of the dividend. That indicates about 11% to 12% for a total return if the share price moves up the same rate as the dividend does, and the dividend rises at my forecast.
But I also pay attention to Morningstar's fair value estimates. I will typically pay a little bit more than our consider buy prices if I see a good, well-funded dividend that I can count on, because that's giving me money back and reducing my capital at risk over time.
But in this case, $28 is OK. Under $27, I'd feel a little bit more enthusiastic about the value I'm getting from the business, and look to call it a buy at that point.
Glaser: Are there any major risks here that investors should be aware of?
Peters: The economy is going to be one. If household spending, consumer finances, remain under a lot of pressure, people aren't eating out as much, it may mean that Sysco falls short on the growth side for another couple of years. If that happens, Sysco might continue to raise its dividend, but the share price might not go up. You might not get that whole 11% to 12% total return that you expect.
But the way I look at it, as long as my income is growing, it's starting off at a pretty good level and it should grow at a pretty good level, I think that this can be a rewarding stock and provide an adequate total return even if valuations contract a little bit, even if growth is a little disappointing in the near term. I'm still willing to look at buying under $27.
Glaser: Thanks, Josh. A good framework for taking a look at dividend stocks.