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Activist investor Nelson Peltz is at it again. His investment firm, Trian Fund Management, has taken a 7.1% equity stake in food distributor Sysco Corp. (NYSE: SYY). This is a very large stake, worth around $1.6 billion.
With that much money at stake, investors can count on Peltz having big ambitions. Various media reports indicate he will seek board seats.
This is an interesting move to say the least, as Peltz is famous for pressuring large companies to break themselves up to create shareholder value. Sysco’s fundamentals have looked bloated in recent years, as the company’s revenue and profits are dramatically slowing down.
Here’s what Peltz may see in this beleaguered food stock.
Sysco Is Getting Squeezed
Sysco is a giant company. It’s a leader in the food distribution business, but it’s not growing. In fact, Sysco’s earnings per share have steadily declined each year since 2010, from $1.99 per share in 2010 to $1.58 per share last year. That represents a 20% decline in profits over that time.
The reason for the decline is that the food distribution industry is highly saturated. Sysco noted in its last 10-K filing with the Securities and Exchange Commission that there are more than 15,000 companies engaged in the distribution of food and non-food products to the food service industry in the United States.
In addition, consumer eating habits are rapidly evolving. Consumers are increasingly opting for fresher, better-sourced foods like organics.
The end result is that Sysco’s profits are deteriorating. And yet, Peltz could see some potential to create value for shareholders.
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Peltz Goes Hunting
One likely reason for Peltz’s significant investment in Sysco is the potential to return a great deal of capital to shareholders. In the aftermath of the company’s failed $3.5 billion takeover of its closest competitor, US Foods, Sysco needs to do something to move the needle. Adding insult to injury is that Sysco had to pay a $300 million breakup fee to US Foods when the merger was blocked.
With the merger off the table, Sysco authorized a $3 billion share buyback. This probably caught Peltz’s attention, and upon looking closer, the famous investor likely realized there was potential for even more cash returns at a company that pays a $0.30 per share quarterly dividend – good enough for a 2.9% yield.
Even though Sysco isn’t growing, it has a strong balance sheet that can be leveraged to increase returns to shareholders even more. It has $5.1 billion in cash and cash equivalents on its balance sheet, compared with just $2.2 billion in long-term debt. In addition, it has another $4.5 billion in treasury stock on the books, which are shares that have been bought back by the company.
Sysco could take out debt to unlock this cash from the balance sheet, which could then be returned to shareholders through additional share buybacks. This would help grow earnings per share, since the fewer shares outstanding would each be entitled to a larger share of profits.
Share buybacks might be the best way for a company like Sysco, stuck between a highly competitive marketplace and a changing consumer landscape, to increase EPS in the near term. This is likely the motive behind Peltz’s latest investment.
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