Sysco Corporation (SYY) Earnings Call Transcript & Summary

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Okay. Good morning, everybody. My name is Ed Kelly, Wells Fargo. I am the food, staples, retail and foodservice analyst. We are very happy today to have Sysco with us at the conference. For those who couldn't be here this year, we hope that next year, you can be. But today, we have Chief Executive Officer, Kevin Hourican, with us; and we also have Chief Financial Officer, Aaron Alt.

So maybe we'll just kind of kick things off. And to start, I'm really just kind of interested in thoughts on current sales trends, what we're seeing in the marketplace. I think there's been talk about a little bit of a step back. I know you guys kind of said that there wasn't, but I think that was more global. So just sort of thoughts on what we're seeing in the marketplace at the moment.

Sure. Happy to. Thank you for having us, Ed. We're glad to be able to be here. And we are not seeing an impact of Delta on our business trends. That's the headline for Sysco. I think what you've heard is perhaps individual companies, meaning restaurant owners or individual doors perhaps were seeing an impact from traffic trends, and we're not. I think it's a testament to your point on the diversification of our business, the global footprint that we have. And frankly, we still have meaningful tailwinds available to us in the recovery in front of us because Europe entered the crisis earlier, had a deeper impact and came out later. So we still have pretty meaningful recovery in front of us in Europe. Foodservice management, travel, hospitality are still industries that have recovery in front of them. But I think important though, even in our U.S. business, we're not seeing impact of Delta on our business trends. They remain very strong.

And do you think some of that is because -- whereas we look at industry data, maybe there's been a little bit of a step back, but fill rates were not -- I don't want to say bad, right? But Fill rates were not where they were pre-COVID. So is some of the void made up with just your ability to supply customers better? And maybe that's why you don't really see much of a step back if we have a little bit of weakness.

Yes. I think it's clear we, Sysco, are taking market share in the environment that we are currently in. Product availability and labor availability are the primary drivers of business success at this time in the environment that we're currently in. As we were talking about before we came on stage, our recipe for growth, which is our long-term strategy, is kicking in and will provide further growth for our company that Aaron talked about on our Investor Day. But yes, right now, the story of Sysco's success is tied to our product availability and our labor availability. What we've said publicly previously is we started ramping up our inventory in our warehouses and our staffing and our operations a good 90-plus days prior to when the industry recovery began. We announced last November actually on one of our earnings calls that we were going to make a meaningful investment in inventory, a meaningful investment in labor. We got started in December. And it's tough out there from a hiring perspective. I'm sure you get questions about that. The head start that we've got from a hiring perspective has clearly helped because the labor market is constrained. Fill rates inbound to us from our suppliers are lower than we would like them to be. Even our fill rates outbound to our customers are lower than what we would like them to be, but we do know we are performing better than the industry at large. On both of those things, we have external data that validates it, and we're winning customers as a result and we're winning share of wallet with existing customers as a result.

So the difference in your outbound fill rates, as you look at your fill rates versus competition, is there a way to sort of frame sort of where you are versus the industry? Is it different sort of where you are versus your larger peers versus sort of middle tier and lower tier? How do we think about that?

Yes. Great question. Our fill rate is directly predicated by our supplier inbound fill rate to us. So think about success or not in this environment is can you get the product from a supplier and then can you properly staff your operations to be able to ship outbound on time and in full. The in-full part for us is not because we can't find it in our warehouse or get to it. It's we either have it or we don't. And there's product shortages in protein, as you're well aware. And there are product shortages tied to palm oil and other unique products where the upstream raw material ingredients are in short supply. The strength of Sysco in that environment is our purchasing size, our purchasing scale. We've got vendor supplier agreements that Sysco needs to be a preferred customer of them given our size, given our scale. Just like Walmart would do in a retail sector, if a CPG is in short supply, pretty confident Walmart is going to get what they order. And no disrespect or ill will intended towards any other smaller distributor, but Sysco's size, our breadth, our depth, our scale and our purchasing economies, when product is in short supply, we will get more than our fair share of product. And part of that is because of the decades-long relationships that we have with these key suppliers. And they can trust in Sysco. They can count on us and we're going to pay on time, and we're going to do what we say we're going to do from a "forecast that we provide them" perspective. So our inbound to us, fill rate from suppliers, despite it being lower than we want it to be, we know it's better than the industry. So we have product available that others might not. But truly, the domain differentiation between top line growth right now or not is, can you properly staff your buildings to be able to cover the loads of the products coming inbound, orders coming inbound to us from our customers. And frankly, even though we are in a better position than the industry, we can be doing even more business than we currently are as we improve our staffing health. And so think about the story of Sysco as we're doing 2 things simultaneously. We're managing a very tight, labor-constrained environment, excellence in execution in that regard, and transforming the company at the same time through our recipe for growth. On that first part, what I say internally is priority 1, 2, 3 and 4 is improving our staffing health. Priority 5 is manage margins because we're in an inflationary environment, but we have a daily stand-up every day that I chair. I end every day focused on staffing. And we know we're doing better than others in the space, and we still have work to do on our own and to be better staffed. And frankly, from our investors' perspective, as we make more progress in staffing, there's more business to be had and we're aggressively going after it.

So the gap in terms of your performance currently versus, let's just call it, sort of industry demand is driven by inventory availability and staffing obviously, right?

Yes.

Are one of those bigger than the other for you?

How are they? Staffing health, which is why I said it's priority 1, 2, 3 and 4. We can see it on our own data. We have 76 warehouses in the United States. We have over 300 "warehouse-like" operations across the world. And I can say with certainty our warehouses that are properly staffed for the environment are killing it from a growth perspective. We have select sites I talked about on our earnings call that are challenged. But for us, it's a reasonably small percentage of our total fleet. And in those select sites, yes, we're not only not growing to 2019. We're actually down to 2019. So if you think about a company that has half their distribution centers in that type of an operating environment, they just aren't able to grow even if there's growth available in the marketplace. So as we're turning the corner in those select locations and frankly over-hiring everywhere, there is new customers to be had. As you called out, there's increased share of wallet from existing customers. So right now, the biggest source of differentiation on growth or not is staffing. The good news about that is it implies a very robust "food away from home" sector because there's a lot of business to be had out there right now.

Right. Okay. So I think investors are obviously very focused on the labor challenges right now. Is there any light at the end of the tunnel that you see, right? Unemployment benefits are sort of rolling off. I don't know what you've seen in those markets from a driver standpoint. Are -- has the pressure started to peak? I think that's what I'm really kind of asking.

I can only speak to our company and our data, what we're experiencing and what we're seeing, and we are making progress. Those are the words that I would use. Again, we're in a general position of health better than the industry and we're making progress. So light at the end of the tunnel is hard to say when will this be behind us, but there are some key points. Point number one -- and this is different than what I have said publicly previously. Now that the remaining states in the country have come off the supplemental unemployment insurance, we have seen a noticeable increase in applicants to our jobs. Previously, we had said it's somewhat immaterial because our wage -- think about our pay of our jobs, is well above that $15 kind of breakeven equation that you've read about or heard about for our restaurant customers. Our wages are well above that. But for the 20-plus states that rolled off on September 1, we've seen a meaningful increase in our applicant flow. So that's really good news, and we're pleased by that. So that's point one. Point two is we've changed and upgraded and improved the marketing of our open jobs. We essentially took that activity and gave it to our Head of Marketing, and they're really good at what they do, so digital advertising, digital communication, digital marketing of our open jobs. We've seen a tenfold increase in the number of applicants showing up for job fairs through that marketing activity. Point three, point four and point five are the things that we've been doing from a compensation perspective to drive behavior. And you've heard us talk about that as mostly transitory. So those are hiring bonuses, referral bonuses, and we're now paying retention bonuses to our driver population so that we're not churning them out to competition who's paying hiring bonuses. So it's not immaterial. Aaron can talk about the math if you're interested. We're making sizable investments in ensuring proper staffing health. The good news though is when we get to that staffing health, the business volume is robust and it's there. The question we get often though is, are these costs permanent? Structural increases to wage, we're being extremely judicious and thoughtful about any permanent changes to wage because you live with those forever. And there have been some. There are some markets where we were under market from a pay perspective and we've had to make adjustments, but the majority of the money that we're spending is in marketing, referral bonuses, retention bonuses and hiring bonuses. And they're making a difference. Where we are making progress, we're turning the corner. That's the term I use versus seeing the light at the end of the tunnel. And perhaps that is a reason why our sales trends are better than some other places that you've been hearing about and things you've been reading.

Okay. And maybe you could provide a little bit more color on the transitory component of the investment into the growth. From a labor perspective, how do we think about what underlying labor inflation kind of really is now versus a normal cycle? How do we think about how much of this is permanent pressure versus just sort of temporary as we're all sort of trying to size margins on the other side of this?

Sure. Thanks for the question. Let me start with the headline, which is we are on track to deliver the guidance that we provided during our last quarterly earnings call. We feel good about where we are for the year. The point of our hiring, our labor costs, et cetera, as Kevin called out, we are facing, as we said we would, what we call the snapback cost, having to invest in our labor and our operations to ensure that we stay ahead of the competitors that are able to service the customer the way that we want to. During Q4, we called out that our snapback costs during Q4 were $36 million. You can assume that during this quarter and indeed Q2 will be at or above that level from a snapback cost perspective. But here's the good news. It's offset by 2 things. One, we're doing this strategically because we -- as we are snapping back, we're also transforming the company, and this is all in service to the long-term growth that we're after. And two, we have the benefit of having gotten started early on cost out. And so while in a normal world or another company, you might say, "Well, gee, that sounds like a lot of money, Aaron, $36 million on snapback. Add that to $50 million on transformation per quarter. How are you going to do that without breaking the balance sheet?" The fact or reality is we started early with cost-out and that's allowing us to leverage our strong income statement, our strong balance sheet to continue making progress against the transformation.

Okay. Maybe just switching gears a little bit but staying on the cost side, product cost inflation. This, to me anyway, seems like an environment where pricing is not an issue because customers can't get product. So can you talk about sort of where we are from a pass-through standpoint on product cost inflation, how long you expect this type of environment to last? I think actually some of the industry data more recently has kind of shown maybe like a little bit of reacceleration and inflation after a little bit of a dip. So just kind of curious just the thoughts on all that.

Well, we disclosed in Q4 we were at about 10% of product cost inflation for the quarter. And what we said at the time was we expected that double-digit level to continue into Q1, maybe into Q2 and then start to level off in Q3 and decline, Q3 and Q4. That's our current -- that's currently what we're predicting for the industry as we carry forward. We're really pleased with our ability to continue to pass the cost through. And of course, in this environment, we're not as focused on margin rate as we are in GP dollars per case, right? And as we use fiscal '19 as the comparison as well, we believe we continue to show great progress on maintaining or improving our gross profit dollars per case really across the portfolio.

And part of what we're doing is, you've heard us say before, roughly half of our customers are through contracts where it's negotiated and it's able to be passed through, and we're managing that very carefully. What Aaron was referring to on the second half is for that local, independent mom-and-pop customer. We're not just forcing it down their throats. We're actually partnering with them. This is -- we have 5,000 sales consultants who work with restaurants to help them be successful. We're educating them on their opportunity to pass through, through menu price increases. And at the last time that we spoke, you asked this question, what -- why would this not be a bad thing? The reason it's not a bad thing is because consumer demand of food away from home has not been impacted in any way because of the inflation. So 10% inflation, we're succeeding investing it through with no change in demand. That is flowing through with increased dollars per case, like Aaron stated, and is currently a tailwind, not to gross margin rate but on GP dollars that we're putting in the bank.

Okay. So you guys are obviously taking a lot of share. You're in a very good position there. How do we think about what's happening from an earnings perspective or margin perspective by customer type? And we all know the independent customers are a good margin customer, right? But that chain customer historically has not been a great margin customer. But we're back into the situation where people are trying to find supply, right? So how are the customer segments sort of looking, from like a profitability standpoint, versus pre-COVID? Because it seems like that should be moving in the right direction here.

I'll start.

Okay.

Great question. Sysco has the benefit where we service every part of that portfolio from the independents through the national chains. And you're right. They are all dealing with their own business issues, whether it's labor or getting the product they want and pricing, and we're responding and working with all of our customers in that respect. When we provided our guidance and our forecast as well, we took into account mix shift over time, how we thought the snapback was going to work through with the national customers, for instance, coming on later as well. And so we're pleased with our ability to maintain our profitability and service the customers notwithstanding which category they happen to be in. Kevin, would you to add?

I'll just add a couple of examples. Early in my tenure with the company, I was often asked the question, where are you going to go, here or here? And it was almost painted as a guns or butter choice, and I kind of bristled at the question because we can grow in both places and spaces if we're thoughtful about the efficiency with which we run the company, increasing throughput capacity, improving how we manage our inventory through omnichannel fulfillment that allows us to free up slot locations for more SKUs in the same amount of space. And our long-term transformation of our company is doing exactly those things. So we don't have to grow in category A versus category B. We believe we can profitably grow in both. But specifically to your question, within each segment of our business, we're working on profit improvement activities. So within SYGMA, we actually announced this on our last quarter, we strategically exited a relationship of a very big customer because the customer didn't meet our profit profile and our profit outlook of what we desire those contracts to be, intentional exit. And we're going to replace that business with customers and contracts that hit our desired or minimum threshold of profitability. So that's happening literally as we speak within SYGMA. Within national accounts, I would say something similar is happening. We're not taking advantage of cost inflation to try to rewrite contracts. We're making sure that we're being paid properly for the services that we perform and the product that we provide. And within each sector, I would say we're working very aggressively and very hard to grow but also to grow profitably from a rate perspective within each sector.

So initially, with the recovery and view on that, which -- I mean actually, I think a year ago to our conference, I -- because I remember writing this note around margins and how -- wow, maybe margins could be better, right, cost saves, share gains, all of that. But the world has kind of changed a lot. And some of the inflationary pressure, while not bad pressure, right, product cost inflation good for gross profit dollar growth, maybe not for margin rate growth, right? So my question is that investors have been very focused on post-COVID margins and the ability of post-COVID margins to get to the level of pre-COVID margins. But is that the right question? And that's -- I'm asking you, right, because we've had a lot -- it looks like there could be meaningful expansion of the top line on all of these. There is some incremental cost pressure, right, which is very clear, but it still seems like that the upside associated with that should be able to offset any of the cost pressure. And the earnings power of this business post-COVID should still be higher than where it was pre-COVID sort of all things being equal. And just kind of curious as to how you're sort of thinking about all that and what the right area of focus for investors are and how confident you are that no matter what happens from a cost perspective, there is enough upside opportunity because of everything else that's going on that your earnings are going to be higher.

I would offer a couple of thoughts. The first -- there's 2 right questions, I would say. The first is -- first, my question is how are you growing, right? And you -- our stated aspiration coming out of our Investor Day is to get to 1.2x to 1.5x market growth. And everything we're doing, whether it's getting out early to attack a snapback or investing for transformation is in support of that growth. And so if you carry that forward, you're right, then how does that lead to the bottom line? And the second question on our margin is both for our guidance for this year, for the full year and even the long-term guidance we gave during our Investor Day did have in it that we would get back to the pre-COVID level margins. Now there's a timing element here. While we don't provide quarterly guidance, I'm going to repeat something I said in Q4 and Investor Day, which is we're dealing with a high inflation environment right now where we're focused on GP dollars, not GP margin rates, of course, right? And we're investing significant dollars against the snapback and the transmission at the same time. And so the first half of our year will have a very different expense profile and gross margin rate profile than the back half of our year or indeed years as we carry forward.

And I'll just add. It's the overall profit ratio of the company that we believe can increase but not necessarily the gross profit rate of the product that we sell, so gross margin of product that we sell. I use our pricing project as an example. Our pricing project is not a gross margin rate improvement project. It is a sales-driving project with flattish margin rates. And an example, we have a category that we know we have been overcharging in a select category over time almost by accident, but we now have the concrete market intelligence at the unique customer level to know when we improve our pricing on that particular category, we sell a lot more of it at a slightly lower margin rate for that product and we put a lot more GP dollars in the bank. And we can offset the margin rate decline for that category by taking slight increases in less elastic product categories. So that's just one specific project, which is our pricing initiative. We have proven that it is driving increased sales at flattish margin rates. And we are pleased to report today that we are now complete with 50% of our country has been migrated to our new pricing platform. A month ago, I said it was 25%. The reason why it's increased is we've completed the rollout to an additional one of our markets, and we will be completely done with that rollout before the end of this calendar year. So we're on track there. So the profitability of this company will meaningfully improve post-COVID versus pre. I think we announced on May 20, at least a 30% increase to our earnings per share, but it is coming from 2 places. It's coming from a 1.2x market growth to 1.35 to 1.50, and it's coming because we're taking meaningful structural costs out of the business. Those 2 things combined is what will result in -- we said at least 30% growth in EPS versus our peak profitability pre-COVID.

You should take it as a sign as well. The fact that we raised our guidance a quarter after having our Investor Day is a sign that there's a lot of things going really well in the business.

And then you've asked me a question off-line. If it's okay, I'll just -- is the fact that the market is recovering going to make it difficult for Sysco to deliver the 1.2 this year? And no. What we've said on May 20, is whatever the market does, if it's recovering faster than we said it would or slower, we will be at least 1.2x where the market is. The market is absolutely recovering faster than what we had modeled back on May 20, which is why Aaron raised our guidance for this year substantially from a sales perspective. And we are confident that we're on track to be able to deliver against that 1.2x growth, which we believe will give investors confidence that our recipe for growth is, in fact, having the impact that we intend it will, which is to take market share over time.

Okay. So there's been a lot of change at Sysco since you've arrived. And it's been changed, obviously, within the management team as well. And I'm just kind of curious how -- if you take a step back, how is everyone settling in. There's an organization under that that's been around a really long time. I'm kind of curious as to how they're viewing the change at this point now that -- I mean the strategy has obviously been pretty well communicated. So I'm just kind of curious just internally how it's all going.

Sure. I love the question. The COVID environment makes it hard to answer this question because it's tough right now with the COVID environment. From a staffing perspective and product availability, yes, people are working long days. Our trucks are going out more full than ever before. The driver's day is longer than it's been before. Those pressures are real and they're felt by all of us, including our leadership team. But when it comes to the confidence in our company and the galvanization of our workforce against our strategy and our purpose, spirits are extremely high. Morale is high. It started with our purpose. We launched a new purpose platform, which is connecting the world to share food and care for one another. And those aren't just words to us. Those are motivating, galvanizing, reinforcing words that raise the bar in what we expect of ourselves and what we expect of each other to deliver a better service outcome for our customers, which then led to our strategy, which is called our recipe for growth that I appreciate you're saying a second ago. It's well communicated. We've worked really hard. Neil and I run the -- he runs communications for us. We work really hard, a clear, coherent and motivating strategy, which is our recipe for growth and that why resistance to change has been meaningfully reduced is the customers in the center. So literally, everything we're doing on our recipe for growth, every single one of the elements improves the customer experience. So when you talk to our 30-year veteran sales force or our 30-year veteran driver or opco president who's been with the company for 40 years, when you say we're going to do X but it's going to make the customer experience better, they're all in. And they lean into it. They pull on the rope as hard as the author of the strategy pulls on the rope. And they are seeing it in the proof of the early innings of the work we're doing. So there was some healthy skepticism 20 months ago when I started on -- is this stuff real? Is it rhetoric? Or is it substance? It's concrete. It's substance. It makes the customer experience better. Example, we waived order minimums last November. We remain the only national distributor who hasn't done that. We are the only -- or that has done that. I meant to say we're the only ones who have waived order minimums. Those things make a difference. And we're going to deliver more frequently than we've been delivering before. That makes a difference. So when our sales team sees that customer reaction, it motivates them to want to get behind the change because change can be hard. But things are going very, very well on the strategy change. What's hard is we're transforming the company for the better while dealing with the COVID crisis. What I would point you to is our market share capture and our financial results that we're producing. And I think those things communicate that we're juggling those balls pretty well.

Aaron, I want to ask you about use of cash. You had an 8-K out sort of last night, how we should be thinking about things like share repo, just any update there you can provide.

Thanks for asking. So our capital allocation strategy is, first, in support of the 1.2 to 1.5x goal, investing into the business organically and inorganically, right? Second part of that is preserve our strong investment-grade rating. The third part of it is return of capital to shareholders. All 3 are important to us, and there are elements of each of them in our transformation plan. The 8-K that, as you were referring to, from last night is last night -- or yesterday, we finalized negotiations with our banks, which removed any covenant restrictions on our ability to either increase our dividend or repurchase shares. That's a good news story for us. We want to get it out there. Similarly, last week, I believe S&P actually raised our investment-grade rating. We went from BBB- to BBB, right? And so the great news there is we're investing into the business, acquisitions like Greco. We have delivered against preserving our strong investment-grade rating with the upgrade at S&P. And now we're taking the steps so that with the frothy recovery we're seeing, assuming that we are fully funded, our investments that we're working on currently, having maintained our strong investment-grade rating, then we can have conversations around what does return on capital to shareholders, share repurchase or otherwise looks like as we move through the year.

And you've had a little bit of work on the M&A side. I think the opportunity has probably not been as big as what we also thought it would be. So how are you thinking about that as part of use of capital going forward? Anything changing from a landscape perspective in terms of the opportunity that's out there given all the challenges that everyone seems to be having?

I'll start with the business strategy, and I'll pass to Aaron from a management of cash perspective. Yes, when I first started, there were lots of questions on our distributors calling you to sell, calling you to sell. And for the first year, my answer was no. There really hadn't been a lot of inbound to us. But the pivot that we've made as a company -- in fact, Joel Grade, who is our former CFO, stepping into a full-time bizdev role, was to just completely change that landscape, not inbound calls to us. Who are we interested in? For what purpose? Why? And the Greco acquisition is the perfect first example of that. We under-indexed in Italian. We didn't have a sufficiently credible product assortment. And the know-how and how-to from a go-to-market selling strategy perspective was not sufficiently present at our company. We studied every available player in the space. Eddie Greco and his family have built a wonderful franchise. And we bought them to help make us credible and relevant in the Italian space, and we're going to take that platform nationally over time. So that's strategy through an acquisition. So the change we've made is that, what businesses do we want to grow? Why do we want to grow them? Can we do it organically or inorganically? In what geographies? For what reasons? And what I would say, Ed, is there are sufficient number of compelling investments for us to go out and deploy our capital against over time. But obviously, we don't talk about any specifics unless there's one to talk about. I'll pass to Aaron for managing the cash.

I would just add that we have ring-fenced sufficient capital to both invest against the business organically, as we've talked about, to preserve the strong investment-grade rating and to issue the dividend that we do every year. And so we're feeling good that whatever comes our way, we'll have the financial resources to be able to respond in service of the long-term growth objective.

Great. Okay. With that, we are out of time. So -- but I did want to thank you again for your participation this year. And it's all. Thank you.

Great. Thank you, Ed.

Thank you, Ed. Appreciate it. Thank you, everyone, for coming.