Sysco Corporation (SYY) Earnings Call Transcript & Summary

Okay. We're going to get started with our next session. My name is John Heinbockel with Guggenheim. And we are pleased to spend the next 25 minutes with the management of Sysco. We have with us today, President and CEO, Kevin Hourican, Chief Financial Officer, Aaron Alt, and Neil Russell and Kevin Kim. But it was about 2 years ago that Kevin joined Sysco right before COVID hit, and over that time period, he has led this venerable organization in its most significant transformation effort in its history. And I think with -- as we sit here today, I think it will be very informative, right, to get an update on where that transformation sits.

So let me just start, Kevin and Aaron, as to kind of level set. Obviously, Omicron has kind of moved through different countries in the U.S. over the last month. How does that, if at all, impact your tactical efforts -- and I imagine it doesn't impact your strategic priorities at all, but does it have any impact on the business in the short run.

Good afternoon, John, and thank you to everyone for joining us today. This is Kevin. You're exactly correct in the fact that Omicron has 0 impact on our strategic imperatives and the long-term agenda here at Sysco. To be clear on that, the transformation that you referenced a moment ago is on track. It is working. We're proud to communicate that for our first half of our fiscal year through the end of November, that's the read we have from Technomic. We sequentially improved each and every month of that first half of the fiscal year from a market share growth perspective and outperforming the market consistently month-over-month. And in fact, that performance, as I mentioned, is sequentially improving. So the work we're doing at Sysco to improved supply chain strength in health, have product available to ship to our customers when they need it, and to transform our company to better serve our customers, is on track. It's winning in the marketplace, and it's working. Your question in regards to Omicron, it is different than the Delta variant. If you remember back in August when asked the question about, is Delta impacting your business, we said pretty definitively, no. We at Sysco are sequentially improving. Omicron is different, and it's different in this way. It is causing governments to once again reintroduce restrictions on our customers that, therefore, then have, John, an impact on our business. Starting in Europe, the 3 major countries that we operate within in Europe, Governments have required employers to force employees to work from home, so very, very strict work from home requirements. And things like curfews and seat capacity limitations have been implemented. Canada, our largest international country. Unfortunately, his recently as last week, imposed closure of restaurants in the Greater Toronto area, in Montreal, Quebec, which is the majority of the population density in that country. Restaurants can still do takeout and delivery, but on-prem dining is closed in large portions of Canada. And here in the United States, not too dissimilar to other variants, Northern 1/3 of the United States versus Southern 1/3 is very different. Southern 1/3 continued to perform well. Cities like Boston, New York, Chicago, have instituted vaccine passport verifications, which is having an impact. John, it's too soon for us to tell the impact that these restrictions on our customers will have on our full year performance. Therefore, we're not going to comment on that today, but we are noticing and experiencing an impact. And more to come to soon on February 8, on our earnings call, we'll be able to talk about this with more quantification.

Maybe as a follow to that, what's your best lead now on inflation and the sustainability of inflation, right? Because as COVID continues to impact supply chain, right, it looks like inflation may stay higher for longer. Thoughts on impact on demand? And then what does that do competitively? And I guess I asked the question, is the pie grows slower, do you think you can grow faster, you'd like to grow 1.5x the market. Can the initiatives you're putting in place drive more share, so you kind of end up at the same place if the pie is growing a little slower?

John, thanks for the question. I'm going to start talking about product inflation, then I'm going to toss to Aaron, who will talk about cost to serve inflation. To answer your question with the definitive, yes. We believe we can grow profitably our market share almost regardless of the inflationary conditions in the marketplace. And we're proving it in the current year-to-date performance, where I mentioned a moment ago we're sequentially improving month-over-month our performance versus the market, and we're on track to deliver our goals of market share growth versus the industry for our first year of our 3-year plan, which is 1.2x the market. As you mentioned, our goal for the third year of our 3-year plan is to grow at 1.5x the industry, and we have confidence that we will be able to do that. From a product inflation perspective, we do not anticipate that double-digit inflation is here to stay, but it is clearly going to be here for longer than what we had indicated at the beginning part of the year. It will eventually moderate, but it's certainly taking longer to moderate than we had expected. What I want this audience to know and to be clear about is the implementation of our pricing software has created a set of capabilities at Sysco that did not exist before. That enables us to be successful in passing on that inflation to our customers, we're contract early, it is appropriate to do so. And we're prepared to manage elevated inflation for as long as it takes. We have a plan to source product competitively. We have a plan to pass through inflation to our customers when and where appropriate. And we have a plan to find menu alternatives, frankly, for items that are structurally dislocated at this point in time and have meaningfully higher than book of business norm inflation. These are the competitive strengths of Sysco being the largest in the industry. We believe we can do this work better than the industry at large. And actually, it can create a success formula. We don't desire for inflation to be at this height for an ongoing period of time for the purpose of consumer demand that you mentioned. But John, we've not yet seen consumer demand impacted by the inflationary pressures that we're currently experiencing. And I want to talk toss it to Aaron, who will comment on cost to serve inflation.

Thank you, Kevin. As Kevin said, we're very pleased with our ability to pass through the impact of inflation on our products. With respect to our operating expenses, in particular, I want to highlight labor and staffing. It is a high priority area for us. We've learned over the course of COVID so far that those that are better prepared certainly can grow faster, and that's what we're experiencing. But we are not immune to the challenging global supply chain environment and indeed, the labor environment that's out there. We have and we will continue to prioritize the hiring and training of new associates, so that we are ready to serve the customers wherever and whenever they want. And we've proven that profitable growth is available to the strong supply chains, and we will put ourselves in that category. So labor availability remains a top priority for us as we push ahead. Now back to reality is that productivity has been challenged as a result of those very same global supply chain and labor issues. Back to reality is that productivity is not as high with new warehouse hires. So there is a short-term challenge that we are going to work through with our snapback investing, as we've talked about in prior quarters as we carry forward. To emphasize, as I guided last quarter, our spending against our Snapback and our transformation would be at least equal to Q1 where we spent $81 million on Snapback and transformation investments. Add to that, the productivity we're addressing and we are going to put ourselves in a place where we are best positioned to compete in the marketplace.

Kevin, 1 of the thoughts was we didn't see as much -- because there was such a quick recovery, right, we didn't see as much competitive fallout from your competitors as 1 might have thought, right, in March of '20. But the idea is that the share then would shift in the recovery, because they would not be able to invest in people and products. Is there a good evidence, as you guys can tell, that they're not able to do that and that is partly the source of your share gains? Is that clear that they're not able to invest in their business the way you -- certainly some of you are?

John, I prefer to comment about Sysco versus other entities. What we can say confidently at Sysco is, as Aaron mentioned, the investments we've made in inventory. We have more inventory on hand now than we did pre-COVID that is enabling us to have a fill rate that is higher than the industry average. We can measure that through Net Promoter Score. Sysco's Net Promoter Score with our customers is significantly greater than the broadline industry at large. The second is the investments in people. We've made significant investments to create awareness of open jobs, adding dedicated recruiters to fill open positions. And as Aaron said, it doesn't come without a cost. We've made sizable investments to create what we call staffing health that allows us to support our customers and grow our business profitably. And then those new people, who come on board, perform at a lower rate of productivity than a 10-year person, which Aaron mentioned a moment ago. These are investments in the near term. But John, more importantly, the point I really want to impress is we're investing to great capabilities at Sysco that will create long-term differentiation. We are meaningfully improving our website. We're investing in what we call a personalization engine, which is aka loyalty program that we'll be able to introduce to customers to provide them with tailored offerings. We're meaningfully upgrading our marketing and merchandising capabilities with cuisine-focused selling as evidenced by the Greco acquisition and then taking that platform nationwide. So I think the biggest point of differentiation you'll see over the next 18 months is while others perhaps have had to sit idle, because of cash flow or balance sheet issues, we've been investing meaningfully during this crisis, and I believe our best days are yet to come. And year-to-date, as I mentioned, we sequentially improved our performance versus the market each and every month through the end of November. And Technomic data will become available to us later in January, and we'll be able to talk about that on our February 8th call.

Now I'm sure you're going to say it's both. But when you think about -- you picked up a lot of new accounts, but you also talked about your average share of wallet is still relatively low. If you look out over the next 3 years, right, through your plan, where is the bigger opportunity, right, existing or new? And then I think we've talked about this before, but when you think about that 30%, as you've gotten further along the line here analytically, do you have a better sense of where that can go to, right? I mean you would think it can go substantially higher, possibly even closer to 50%, but maybe touch on that topic.

I know you love this question, and I love talking about it. There's 3 numbers that we've talked about at Sysco, which is 16, 30, 50. 16% market share, 30% share of wallet, 50% customer doors served. We could update the first number. We're now at 17% market share. You may have seen that in some of our prior reports that we've issued, but we're now at 17% market share. And that number moves when the other 2 move. And we're very bullish on increasing share of wallet. We've not gone public with our longer-term goal for what that share of wallet would be and should be. But what I would submit, respectfully, is each of the 5 elements of our recipe for growth is dedicated towards improving the experience that we provide to our customers. Better digital tools, better merchandising, better selling capabilities, more agile delivery and then acquisitions like Greco, which improve our assortment, also improve our ability to penetrate. So we're bullish. And if you -- as you've asked before, if you could do just 1 thing, what would it be, win more with the existing or win net new, you'd choose to win more with existing. But we don't believe it's a guns or butter choice. We believe we can absolutely increase penetration with existing customers while simultaneously winning new customers, and we're doing both at the present time. Most recent data that we just received from our reporting group, and I'll toss back to you is the number of customers of Sysco's that are now exclusive to us has increased over the last 6-plus months, and the number of new customers that we serve has increased over the last 6 months. And John, it's those 2 things working in concert that are creating the performance versus the market that is growing at Sysco over time.

One of the things we talked about, I think maybe this was 4 or 5 months ago, was the idea of automation, and to deal with some of the labor challenges. And I think it's difficult. I think it's difficult to put automation into the DCs there's an opportunity to put it on the trucks and make the drivers more productive. Maybe an update on both of those, particularly the driver piece?

Yes. For sure, as cost of labor increased over time, it increases the prioritization and importance of automation. That's an every industry sector topic. It's also just purely the fact that you can't hire as many people as perhaps once we could. And therefore, automation is important for that purpose, too. And you hit the nail on the head, John. The majority of our expense is not on the warehouse. It's actually the drivers out on the truck, delivering to our hundreds of thousands of customers. And when we can improve the productivity of that driver, we can increase the number of customers we serve, we can lower our overall cost to serve. And the work we're doing right now is to increase the drivers' speed and efficiency, not of driving, but of unloading the truck at the customer's restaurant location. And there's some work we're doing with world-class material handling equipment manufacturers. Too soon to talk about the details of those pilots, but we have multiple pilots in flight as we speak. We have 10 different pieces of equipment that we are piloting. These pilots are showing promise. It also improves driver retention, because our drivers love this equipment that we are providing to them. It decreases the wear and the tear on their body, decreases the amount of physicality of the driver route. So we're pretty bullish on that. And then within our warehouses, we're never going to have a completely robotic building. The type of products that we sell and ship to our customers like a 50-pound bag of rice is not conducive to be thrown on a conveyor belt and handled through sortation. These products that we carry are damage -- high-end damage rate and the shrink cost would be pretty significant with full automation. With that said, we don't have to automate everything to add efficiency to our buildings. There's things that can be done with palletization, inbound automation and as well as high bay storage, automated storage and retrieval systems, which, of course, we're evaluating all of those things. So we got a crack pot team of engineers, John, on this. And again, it's another point of differentiation. We can make investments in those types of capabilities that smaller players aren't able to do.

Where do you think you are on the SKU rationalization journey? And this tension right between -- we have to have enough assortment to serve our customers, but maybe we don't need x number of French fries and we can trade the customer off. How much more can be taken out of the assortment pipeline?

Yes, John, there's no better time than the present to be attacking SKU productivity and getting rid of the long, right SKU tail of unproductive product and getting to a more common assortment at Sysco is a priority for us. It helps in many ways. It improves our negotiations and relationships with suppliers. It improves our ability to in-stock on those items that matter most. It opens up SKU space in our warehouses for unique products that we can add to our warehouses, like Greco acquisition to create space for Greco in other parts of the country, we can attack that SKU right tail, free up slots in our buildings to be able to bring in those unique products. It also helps us lower our overall inventory across the network over time. So while we've not gone public, John, with a quantified goal for these elements, improvement in this regard is built into our long-range financial guidance, and we are meaningfully addressing this through a global inventory function that we've created over the last year.

The -- maybe sort of -- when you think about -- again, you've added a lot of new accounts over the last year. Maybe touch on capacity. So capacity in the warehouses, capacity from a driver's standpoint or from a salesperson standpoint. And the idea -- I guess, you're not at a point where if we're bringing on new accounts and don't quite have the capacity and the experience may not be perfect. You haven't gotten to a point, where you slowed down the number of new accounts because of those capacity constraints, correct?

New accounts and winning new accounts is not a reason for Sysco to not be able to continue to grow or support our existing customers, John. The challenges that exist in the industry are actually more tied to product availability and labor availability, and that's agnostic to the number of unique doors we serve. So there are certain items that are meaningfully constrained where we're on allocation from suppliers. And new account wins is not creating that problem. That is a global supply chain challenge. And as Aaron mentioned in his remarks, we're doing a lot to increase the availability of labor. But we've proven over the last 6 months with our Net Promoter Score being strongly better than the industry average that we're serving our customers better than the market, and that's inclusive of winning more new customers than at any other point in time in our company's history. So to improve customer experience, we're focused meaningfully on inventory availability and product availability. And then for the longer term, I'll pass to Aaron, who can comment upon our CapEx and what we're looking at as far as supporting growth into the future. Aaron, over to you.

Thank you, Kevin. As Kevin commented earlier, Sysco is playing the long-term gain, right? We are able to serve now, but we're not resting on what we can do now. We are purposely investing against our distribution nodes, against our fleet, against our technology, against our capabilities, so that we never have to have the conversation around the idea that somehow we would be capacity constrained as we carry forward. And that's a key part of the recipe for growth that Kevin announced back at our Investor Day. And I just want to go back and reemphasize. It's got 3 parts in order, investing for growth. Growth is how we are measuring success at Sysco, profitable growth, of course, right? And we are making the investments now. We'll talk more about those as we carry forward, but we're pleased with our progress against that investment, although I will observe given the global supply chain environment, which we're operating, as we prepared for, we have the opportunity to rephase and retime some of those investments without impacting the actual growth profile or our metrics of success. Secondly, maintaining the strong balance sheet, so that we can always invest where we need to against the business. And many of you will have seen the actions we took in Q2 publicly around addressing some of the -- some of the COVID responsive indebtedness we took in place with the paydowns and the refinancings that we launched during the quarter. And lastly, our shareholder returns as well. We've said publicly before where we don't have a use for cash, while maintaining an appropriate fund, we will return capital to shareholders, and we announced in our last earnings call, the idea that we were going to begin share repurchase during the second quarter of up to $500 million during the fiscal year of share repurchase. And I'm happy to be able to talk today about the fact that having invested against our company everywhere we think we need to, having taken actions against the balance sheet in ways which are already publicly available, we also did during the quarter repurchase approximately 5.6 million shares using about $416 million of cash at average price of $72.30. So we're quite pleased with our ability to deliver against every element of our recipe for growth and our capital allocation during the quarter.

So maybe as a follow-up to that, what do you guys think is the right level of leverage for the business? Is it different post COVID than pre given -- I don't think we're ever going to relive that again? But does that change your thinking? And then from an M&A standpoint, how do you think about something more global? Because obviously, there's global food service opportunities, which you can bring a lot of your learnings to from the U.S. How do you think about global M&A relative to more Grecos?

I'll start with the debt piece, John. Thank you. We committed that our net debt-to-EBITDA leverage target will be [ 2.5 to 2.75 ], and we're not backing away from that. Of course, it's got the 2 components, is bring our debt down, which we've demonstrated that we're doing and then also growing EBITDA over time, which we're also making progress against doing. So I'm not here today to say that it's going to be anything other than the 2.5 to 2.75. But here's the important difference. In building that leverage target, we took into account what we expected the investment profile would have to be against investing in the business, investing in the growth as we carry forward and actually also preserved cash to be able to continue to take advantage of opportunities as they come -- as they have come to us similar to the Greco investment. Kevin?

In regards to the second half of the question on M&A. M&A has been and will continue to be a component of our growth here at Sysco. But I would actually prioritize the U.S. first before international from an M&A perspective. And specifically, what we're looking for there are either merchandising capabilities that are additive to our assortment as evidenced by Greco. We under-indexed in Italian, Greco was the best and largest independently owned with a PE investment, but a privately held company. And they were just a wonderful addition to Sysco. The other opportunity there is geographic white space. In our specialty businesses, we have some geographic white space, and we would like to be able to fill out that network across the country. And so we rank those high and why is high confidence in rate of return for our shareholders and for our own internal expectations. We do anticipate being able to profitably grow our international business. Step 1 is to straighten up our own performance internationally from that business being a tailwind -- excuse me, a headwind to Sysco to being a tailwind, which is actually showing up in our year-to-date performance. We can talk more about that in the future. And John, we will do some international investments and acquisitions over time, but I wouldn't say that's a near-term opportunity.

And maybe we have 2 minutes left. So my last question. So if you think about, you've got the various strategic priorities you've referenced. If you had to pick one, would it be the personalization engine that could be the most impactful in driving that 1.5x the market growth?

I'm going 2 and I'm going to give you 1 for sales, 1 for operations, John, if that's okay. From driving sales growth perspective with increasing that share of wallet, yes, it's the personalization engine. There's nothing like it in this industry, and we are proving through manual pilots that when you provide an independently owned mom-and-pop restaurant customer, a tailored promotional offering that fits their needs, they buy more from Sysco. So yes, that is the 1 we're most bullish on. On the operations side, it's omnichannel inventory fulfillment. I think you know in our industry, we're mostly single DC to single customer, and we can unlock meaningfully enhanced SKU offerings and do so more cost effectively through our omnichannel supply chain inventory project, which is a multiyear build. And we're about halfway into that physical systems build and infrastructure build. And when that is available, again, we'll be the only food service distributor providing specialty broadline enhanced SKU offerings at a cost to serve and speed of agility of delivery performance that will be second to none in the industry.

Okay. Thank you. I think we've run out of time. But thanks, everybody for listening, and there will be a breakout session a little later on this afternoon. Thank you, guys.

Thank you John.