US Foods Successfully Expands Profit Margins, but We Think Market Share Gains Will Remain Elusive

No-moat US Foods’ third-quarter results support our long-standing view that the firm is likely to achieve two of its three long-term strategic priorities (expanding gross margins and leveraging operating expenses), while its third objective (gaining market share with restaurants, now 60% of sales) should prove challenging. It appears that US Foods did not gain restaurant share in the quarter, as its 2.9% case growth with independent restaurants lagged the 5.4% growth realized by narrow-moat Sysco and the 4.6% growth experienced by no-moat Performance Food Group. But, as we expected, US Foods expanded its gross margin by 30 basis points to 16.4%, driven by savings in inbound logistics and the effective management of inflation (and deflation in proteins). US Foods also succeeded in leveraging operating expenses, which fell 10 basis points to 13.6% of sales, as savings (new warehouse processes, routing improvements, and an automated warehouse picking technology) more than offset higher labor costs. While wage inflation and turnover are elevated versus last year, these metrics have improved since last quarter and should continue to improve as the softer economic environment is bringing the labor market back into balance. On that front, management stated that overall industry demand was soft in July but improved modestly by September. We expect flat cases for the food service industry and US Foods over the next year, below our 2% long-term forecast, as consumers should eat at home more often to help manage inflation.