Despite the high-single-digit downdraft in shares following first-quarter results (3.9% reported sales growth, 1-basis-point bump to gross margin to 19.08%, and 6 basis points of adjusted operating margin expansion to 4.55%), we continue to view Sysco’s (SYY) shares as a touch inflated relative to our $57 fair value estimate (which we expect to tick up by about $1 per share to reflect additional cash generated since our last update). While we haven’t wavered on our thinking that Sysco benefits from its scale advantages and low-cost position (the crux of our narrow moat rating), we attribute the market’s disfavor to compressed earnings on inflationary headwinds (particularly as it pertains to transportation and logistics).
While these cost pressures are far from a positive, the impact is not dissimilar from what we’ve seen at other consumer product firms and largely reflect a tight labor market (and subsequent shortage of truck drivers across the industry, as opposed to factors unique to Sysco). And we anticipate that accelerating the efforts already in place to enhance its supply chain capabilities and more efficiently use technology across the organization (as part of efforts to drive $650 million-$700 million of operating income improvement through the end of fiscal 2020) should ensure gross profit growth above operating expense growth persists longer term (in line with the 3.9% versus 3.8% growth this quarter and the 4.8% and 4.1% respective gains on average over the past five quarters). However, we don’t posit that the entirety of any savings realized will drop to the bottom line but rather will be funneled back into the business to offset intense competition. As such, we don’t foresee a material change to our long-term expectations calling for 3%-4% annual top-line growth and operating margins of about 5%.
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Erin Lash, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.