Get Income and Growth From This Niche Stock

Jay Peroni's picture

Wednesday, February 27, 2013 - 11:30am

by Jay Peroni

When looking for solid dividend-paying stocks, it makes perfect sense to seek out yields that exceed the historical 3% rate of inflation. Although it's extremely important to own a high-yielding stock for an income-oriented portfolio, the financial condition of the company is by far the most important element when deciding which stocks make the cut. After all, is a 16% yield really that attractive if the company is in the process of declaring bankruptcy?

But as I search for high-yielding stocks among macroeconomic investment themes -- aging baby boomer population, rebound in the housing market, slow-growing economy -- I always find myself drawn to solid, niche stocks in the agricultural and food industries.

This is because the rising global population is contributing to a substantial increase in food consumption and demand, particularly in emerging markets, where fast-growing middle classes have more money to spend on food.

What's more, this trend is set to explode in the coming decades.


 

Not all food companies are created equal, though. Some have distinct advantages over the competition.

In fact, I found one company that's the market leader of food-service distribution in the United States and Canada, controlling nearly 18% of the estimated $225 billion market.

Yielding a solid 3%, Sysco Corp. (NYSE: SYY) has more than 400,000 customers in niche segments like education, health care, restaurants and lodging. Its large distribution network combined with a vast product selection gives it a competitive edge. In addition, Sysco has a whole array of national, regional and ethnic brands that offer a variety of fresh foods and supplies.

If you've eaten out or traveled lately, then you may have already used its products. Its restaurant products range from kitchen equipment, dishes and glassware to eco-friendly disposables. In the hotel segment, it offers a wide variety of items, including bedding and guest soaps. Its services include restaurant design, menu consultation, marketing support and employee training, among other activities.

In addition to its strong customer base, the company's supply-chain initiatives have allowed it to consolidate inventory and gain leverage over the competition. With nearly twice the market share of its closest rival, Sysco has generated returns on invested capital of about 19% during the past five years. And because no single customer accounts for more than 10% of Sysco's consolidated sales, the company was insulated from some of the ill-effects of the global economic downturn.

Despite its current low-cost operations, Sysco continues to look for ways to improve its bottom line. One way is through improving its existing supply chain by routing deliveries more efficiently. It has also concentrated on optimizing its product sourcing and enhancing supplier relationships.

With these implemented changes, management expects cost savings to amount to about $600 million during the next few years, along with a higher profit margin of about 5.3% by 2016 from a current 5%. These increased margins will aid profitability and could allow Sysco to keep raising its dividends.

Take a look at the annual increases during the past five years:

Income and growth
In addition to increasing its dividend consistently, Sysco's stock has seen major growth, up nearly 50% since 2009.

Take a look at the chart below...

Although it has established a dominant market share, Sysco has shown that is still has plenty of room to grow. Last year, the company recorded its highest sales revenue during a quarter, with sales of $10.8 billion. In fiscal 2013, Sysco has sought out its competition by acquiring 10 companies.

Sysco's forward price-to-earnings (P/E) ratio of 18 puts its valuation around $35-36 a share, so it currently looks attractively-priced compared to its peer group's P/E of 19.3. Its enterprise value/EBITDA ratio, which is another measure to value a company, is 9.6. It also has an impressive free cash flow yield of 4.7%. What's important is that sales have been growing in the mid-5% range and this trend should continue throughout 2013.

Sysco is also in solid financial shape. Its total debt-to-capital ratio is low at 0.4, with operating income covering interest expenses by almost 17 times. It currently has a Standard & Poor's credit rating of "A+," which is a very low default risk.

Risks to Consider: If food inflation continues to accelerate, then this could negatively affect Sysco's margins and impair its financial results. Because 60% of sales come from the restaurant industry, Sysco is highly dependent on consumer spending, which is often fickle. Input costs for food and transportation of food account for a significant portion of Sysco's costs. Thus, a major increase in commodity prices could negatively weigh on results.

Action to Take --> Buy Sysco up to $36 a share. With a solid 3% dividend, a strong customer base and being market leader, Sysco is poised to continue growing at its historical 8-10% rate. I anticipate shares could hit $43 during the next 12-18 months, representing a potential gain of 20-25% from current levels.

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Jay Peroni does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.