Ongoing scrutiny of health care costs and continued reliance on acquisitions to fuel growth bring risks to the company, but we don"t think the risks are excessive.
INCOME.
Suburban Propane Partners, L.P.
Ticker symbol: SPH (NYSE) S&P rating: BB Value Line financial strength rating: B+ Current yield: 6.0%
Company Profile
You probably know this company best for its propane distribution business and the white sausage-shaped tanks dotting the landscape, especially in rural areas, and for the trucks serving them. Suburban Propane Partners, L.P., through its subsidiaries, engages in the retail marketing and distribution of propane, fuel oil, and refined fuels, and to a lesser extent, in the marketing of natural gas and electricity in the United States.
The Propane segment is the largest segment, and engages in the retail distribution of propane to residential, commercial, industrial, and agricultural customers, as well as wholesale distribution to large industrial end users. The Fuel Oil and Refined Fuels segment engages in the retail distribution of fuel oil, diesel, kerosene, and gasoline to residential and commercial customers for use primarily as a source of heat in homes and buildings, primarily in the East, while the Natural Gas and Electricity segment markets those commodities to residential and commercial customers in the deregulated energy markets of New York and Pennsylvania.
Suburban Propane Partners, L.P., is also involved in selling and servicing heating, ventilation, and air conditioning (HVAC) units that consume its fuels. As of September 2010, the company served approximately 800,000 residential, commercial, industrial, and agricultural customers through approximately 300 locations in thirty states, concentrated in the East and West Coast regions of the United States, including Alaska.
Financial Highlights, Fiscal Year 2010
Despite the visibility of the white tanks in the residential segment, Suburban"s business is more concentrated in non-residential customers, accounting for some 63 percent of its customer base, and these customers have been hurt by the recession. The recession brought a decline both in volumes and in selling prices, with propane gallonage dropping some 7.6 percent through FY2010 from the year before. At the same time, input costs began to rise with energy prices in general in FY2010, putting a pretty tight squeeze on profits. The company booked $1.14 billion in sales in FY2010, comparable to FY2009, but off almost 28 percent from the demand and price-cycle highs in 2008. Earnings came in at $3.26, reflecting a steady modest decline in place for three years, excepting 2008.
This may all seem like bad news, and it is to a degree, but the company had the advantage of strong financials behind its back. Cost-cutting efforts and a relatively strong cash position and cash flow position covered the generous payout with no real concerns, and the company was able to raise the payout, albeit slightly, for the nineteenth consecutive year in early 2011. As 2011 unfolds, colder than normal weather and a stabilizing macroeconomic environment have brought cautious optimism.
Reasons to Buy
The main draw with companies like Suburban Propane is the high, steady, and growing dividend. SPH pays out between 70 and 95 percent of its earnings each year as dividends, although the payout ratio slightly exceeded 100 percent of earnings, but still only about 80 percent of cash flow. In such an arrangement, shareholders are treated like true owners.
Customers who use propane are likely to continue doing so, and propane commodity prices appear to be relatively steady and predictable. Suburban Propane and many of its peers appeal to investors who want the relative safety and security of a utility dividend, but don"t want to be exposed to such things as regulatory agencies, nuclear power, high power plant development costs, environmental issues, and other complexities inherent in running a big utility company
Reasons for Caution
As previously mentioned, the recession has. .h.i.t small businesses hard, and many of these users may be gone for good. There don"t appear to be any substantial growth drivers in the form of new propane users on the horizon, although the company has made a few "bolt on" acquisitions in key markets to leverage its operating platform. Additionally, low natural gas prices may motivate some customers, especially in urban fringe areas, to switch away from propane. Suburban should be looked at as a utility, with a relatively steady customer base and a high payout from earnings. This issue should be bought for income, not for price appreciation.
CONSERVATIVE GROWTH.
Sysco Corporation
Ticker symbol: SYY (NYSE) S&P rating: A+ Value Line financial strength rating: A++ Current yield: 3.7%
Company Profile
Sysco is the leading marketer and distributor of food, food products, and related equipment and supplies to the foodservice industry. The company distributes fresh and frozen meats, prepared entrees, vegetables, canned and dried foods, dairy products, beverages, and produce, as well as paper products, restaurant equipment and supplies, and cleaning supplies. The company might be familiar for its "inst.i.tutional" number ten-sized cans of food found in many high-volume kitchens, but the product line and customer base is much larger, including many specialty and chain restaurants, lodges, hotels, hospitals, schools, and other distribution centers across the country. If you eat out at all, you"ve most likely consumed Sysco-distributed products.
Sysco was founded in 1969 with the goal of becoming a national foodservice network. By 1977, the company had become the largest foodservice supplier in North America, a position they have retained for more than thirty years. They conduct business in over 100 countries.
Sysco operates 186 distribution facilities across the United States, Canada, and Ireland. Their ninety-nine Broadline facilities supply independent and chain restaurants and other food preparation facilities with a wide variety of food and non-food products. They have seventeen hotel supply locations, sixteen specialty produce facilities, twenty SYGMA distribution centers (specialized, high-volume centers supplying to chain restaurants), twelve custom-cutting meat locations, and two distributors specializing in the niche Asian foodservice market.
The company also supplies the hotel industry with guest amenities, equipment, housekeeping supplies, room accessories, and textiles.
Most people are unaware of just how many times during the day they cross paths with Sysco"s products and services. Sysco"s distribution facilities provide over 400,000 different food and related products (including 40,000 with Sys...o...b..ands) to over 400,000 restaurants, hotels, schools, hospitals, retirement homes, hotels, and other locations where food is prepared.
Sysco is by far the largest company in the foodservice distribution industry. The company estimates that they serve about 16 percent of a $231 billion annual market. Sysco"s sales dwarfs those of its two chief compet.i.tors, US Foodservice and Performance Food Group.
Financial Highlights, Fiscal Year 2010 (ended June 2010)
The recession hit the restaurant industry hard, and FY2009 sales dropped 1.8 percent from the prior year, not too bad considering the large number of restaurants that disappeared from the landscape. The restaurant business, and particularly some of the larger chains, continued to cut back in 2010, but Sysco managed to recover about half the business lost during the previous year.
Cost-cutting measures and moderating commodity prices gave the company a bit of an earnings tailwind; combined with share buybacks (2 percent of float), per share earnings rose from $1.77 to $1.99. The company took the opportunity to raise the dividend to $1.04 per share per year, a nice gesture to shareholders. The company"s shares, however, got "cooked" in February 2011 with an announcement of projected margin pressures due to rising commodity prices; in particular, double-digit cost increases in meat, dairy, and seafood prices were in clear contrast to slight deflation seen the year before. FY2011 Q2 earnings came in slightly below expectations at $.44 versus an expectation of $.47. The stock lost 6 percent of its value over the announcement, but the company did not announce any guidance other than to say things would be a bit more "choppy."
Reasons to Buy
Sysco continues to be a dominant player in a niche that won"t go away anytime soon. While near-term commodity prices may add some cost pressure, the value of the franchise and near-term sales should remain unchanged; we think the worst is over for the recession and that any such recurrence in the future should only temporarily slow the business.
Sysco keeps margins high by selling products under its own label, a strategy it began a year after its founding. Its private-label business carries an estimated 24 percent gross margin, or 10 percent more than it earns on national brands. This is a very healthy figure in the food industry.
Sysco"s recent investments in technology continue to bear fruit. Improvements in routing and inventory management have allowed the company to increase its shipment frequency by 10 percent with 4 percent fewer people, all while using 10 percent less fuel. Shipments per man-hour are up 15 percent, cases per trip are up 2 percent and errors are down 3 percent, according to the company.
The foodservice business is highly fragmented. Sysco is the largest player with approximately 17 percent market share, and over half the market is split among companies holding less than 1 percent each. This would be a good time to grow market share through acquisition, and Sysco"s balance sheet is solid. Of interest is the fact that in the past two years Sysco"s two largest compet.i.tors were bought and taken private by equity firms.
In sum, this is a steady and safe company with a healthy payout to customers, and has experienced some price dips giving good buying opportunities.
Reasons for Caution
Although the trend is slowing, the recession got many folks away from the habit of eating out, and restaurants and hotels are buying less food and fewer supplies and equipment. Many restaurants disappeared altogether, although we expect that better times will bring most back in some form. Investors seeking rapid growth might want to look somewhere outside of this steady and rather uns.e.xy business.
AGGRESSIVE GROWTH.
Target Corporation
Ticker symbol: TGT (NYSE) S&P rating: A+ Value Line financial strength rating: A Current yield: 1.9 percent
Company Profile
Target is the nation"s second-largest general merchandise retailer, and specializes in general merchandise at a discount in a large store format. The company now operates nearly 1,740 stores in forty-nine states, including 251 "Super Targets," which also carry a broad line of groceries. The greatest concentration of Target stores is in California, Texas, and Florida, with a combined total of about 30 percent of the stores. There is another concentration in the upper Midwest. With the sale of Marshall Field and Mervyn"s in 2004, the company has focused completely on discount retail in store locations and on the Internet. In 2000, the company formed "target.direct," the direct merchandising and electronic retailing organization. The business combines the e-commerce team of Target with its direct merchandising unit into one integrated organization. The target.direct organization operates seven websites, which support the store and catalog brands in an online environment and produces six retail catalogs.
Target positions itself against its main compet.i.tor, Wal-Mart, as a more upscale and trend-conscious "cheap chic" alternative. The typical Target customer has a higher level of disposable income, which the company courts by offering brand name merchandise in addition to a series of largely successful house brands like Michael Graves and Archer Farms. The company"s revenues come from retail sales and credit card operations. Target is one of the few retailers that still finance its in-house credit operations, although in-house credit operations have given the company some problems in tougher times. The company has been looking to sell the receivables and financing operations while still maintaining operational control of the in-house credit name.
Financial Highlights, Fiscal Year 2010 (ended January 31, 2011)
Target took some lumps during the recession, but the strong value proposition of quality for less resonated well with most customers. Although comparable same-store sales were off slightly, store openings kept revenues growing at a modest, low single-digits clip between FY2007 and FY2010. In the second half of FY2010, comparable same-store sales began to improve into the 24 percent range on the way to an overall 4 percent revenue increase. While margins have remained steady, a reduction in bad debt losses and some new creative merchandising initiatives brought substantial earnings improvement to $3.88 per share in FY2010, an 18 percent rise. Cash flow has been strong, at almost $7.00 per share in FY2010, and the company has been very aggressive with share repurchases, buying back 25 million shares in FY2010 and some 230 million shares since 2003 to get to an estimated 690 million share count by the end of 2011. The company also reduced long-term debt by $300 million during the year.
Reasons to Buy