DBRS Confirms Sysco Corporation Ratings at AA (low) and R-1 (middle), Trend Stable

DBRS has today confirmed the long- and short-term ratings for Sysco Corporation (Sysco or the Company) and Sysco International, ULC (based on the guarantee from Sysco) at AA (low) and R-1 (middle), with a Stable trend. Sysco possesses an inherently strong earnings profile based on its position as the largest foodservice distributor in North America, efficient operations and record of growth. Although the Company performed satisfactorily in the challenging economic environment of the past three years, DBRS is concerned that continued weakness in the economy will pressure growth and profitability further in the near term.

In F2011, Sysco’s net sales increased by 5.6%, driven primarily by price increases (accounting for 4.6%), with the remainder of the increase coming from volume, acquisitions and positive foreign exchange impacts. (Note: F2010 contained 53 weeks. Adjusting for the additional week in F2010, net sales in F2011 actually increased by 7.7%.) Cost of goods sold increased 6.2% in F2011 due to food cost inflation, and operating expenses rose 5% due largely to higher expenses for salaries and related costs, as well as the Company’s business transformation initiative related to its Enterprise Resource Planning (ERP) system. Although substantial, Sysco’s price increases and expense reduction initiatives were not sufficient to completely offset these rising input and operating costs, resulting in a 50 basis point reduction in the EBITDA margin. As such, EBITDA for F2011 decreased moderately by 1.4% to $2.3 billion.

In terms of its financial profile, the Company continues to benefit from its strong cash generating capacity, which has historically been coupled with generally prudent financial management. Cash flow from operations decreased modestly to $1.5 billion in F2011 (vs. $1.6 billion year-over-year). Capex increased 7% to $636 million, and dividends increased modestly to $597 million in F2011. A $390 million increase in working capital requirements resulted in negative free cash flow of $142 million for the year.

Acquisitions and divestiture activity was not material in F2011 and share repurchases were more than offset by proceeds from the exercise of options. As such, Sysco’s gross debt increased by $188 million, and gross lease-adjusted debt-to-EBITDAR increased to 1.27 times (x) from 1.16x in F2011.

Going forward, DBRS expects a challenging economic environment and believes that product cost inflation may pressure growth in profitability in the near term. Top-line revenue should increase in the low to mid-single-digit range over the near to medium term, based primarily on pricing and minor acquisitions throughout the year. Margins are expected to remain under pressure during F2012 as rising input costs, resulting largely from food inflation, may be difficult to fully pass on to consumers. As such, Sysco’s EBITDA is expected to remain flat at best in the near term.

Sysco is expected to increase cash flow generated from operations to approximately $1.7 billion, due primarily to the completion of a three-year Internal Revenue Service settlement during the course of F2012. Capex requirements are expected to remain high, at approximately $750 million to $850 million through F2012, as the Company continues to expand new facilities and renovate its existing ones, and invest in its ERP business transformation initiative. With a modest increase in dividends in F2012, DBRS expects Sysco’s free cash flow before changes in working capital to be in the range of $200 million to $300 million. Share buybacks are expected to increase during F2012 to offset proceeds from the exercise of options; as such, debt levels should remain fairly steady throughout the course of the year. However, further softness in operating income or more aggressive-than-expected financial management would result in pressure on the rating.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.