Leading Grocer: SYY

Sysco Corporation (SYY) is the leading grocer to restaurants. "Eating out" (foodservice) and "eating in" (retail) now make up roughly equal shares of the total U.S. food dollar with each grossing (a word derived from grosse, meaning twelve dozen, that also led to the word grocery) about $500 billion.

Eating out is a broad category, including schools, hospitals and supermarket services. For years foodservice was gaining share from retail, but has levelled out since 1998. Excluding supermarket and fast food categories, SYY has roughly 15% market share of selling groceries to foodservice, a $200 billion category.

SYY gets slightly over 50% of its revenues and most of its profits from "street customers," a term it uses to describe independent restaurants. The independent restauranteur is declining in the take out category, but is thriving in the full-service arena. SYY is a valuable ally to these customers, equipping them with the benefits of technology that would normally be available only to large scale buyers such as McDonalds.

Viewed in these terms, SYY is similar to Wal-Mart (WMT), another "leading grocer" with over 24% market share. Just as SYY expands the purchasing power of these "street customers" with scale and technology, so does WMT expand the purchasing power of its customers with scale and technology. However, SYY's customers use the expanded power for competitive purposes in business, while WMT's customers use that power to enjoy a wider range of products and services.

Based on this comparison, I tried to compare the long term stock price performance of the two companies. This graph shows the result:

Through 2003, these two stocks had similar performance, but have diverged since then. Looking at their financials, I saw they had similar results. However, the market gives SYY a P/E of 24 that is significantly higher than WMT's P/E of 18. In fact, past divergences in price are also mostly caused by P/E (market value) differences, not operating ones. (Here it appears that WMT has compelling value versus SYY.)

Interesting to me, SYY has almost 9,000 trucks while WMT has about 7,000 trucks, even though the gross revenues of WMT (in the U.S.) are almost eight times greater. This difference indicates that SYY could have some real improvements in the distribution area with its much anticipated redistribution centers (RDC). Look at the following graph the company has supplied:

If trucking times improve as indicated, either less trucks will be required or a greater volume will be moved with the same number of trucks. In either case, SYY will have moved another step towards helping its customers compete.

Hedge Hog?

As I wrote in an earlier blog, I continually look for cochamim, "wise ones" to learn from. One good way is to look for the footprints in the sand and James H. Simons is making big footprints. In fact, his footprints are so large that I'm leery about their accuracy.

James H. Simons is an accomplished mathematician turned hedge fund manager. For 2005, he was the top money-maker with his reported take-home pay to be $1.5 billion. The math for his compensation does not require a Ph.D; he earns a 5% fee plus 44% of outperforming his benchmark. (And to think that I was squeamish about 2% plus 20% of outperformance!) As if that compensation number is not mind-boggling enough, his investing techniques are even more alien.

He is a "high frequency" hedge fund manager. This new breed uses advanced mathematical and scientific processes to detect the "visible hand" in the tick by tick trades in the stock market. This relatively unknown trader's firm is reputed to make over 10% of the daily trades on the NASDAQ.

His returns are extraordinary. Apparently he has exceeded 35% per year for over 20 years. But these returns are not verified nor are his processes public. For years, the claim has been made that his firm, Renaissance Technologies, would not market, nor even need to market. Despite those claims, Renaissance cranked up the marketing and moved from $5 billion to $16 billion in assets under management (AUM) by the end of the year 2006.

Was $1.5 billion in compensation not enough?

Battered Stocks?

Recently, someone referred to "battered stocks." There hasn't been much battering lately, but it is where the big gains can often be found.

GEICO is one of Buffett's largest and longest-held stock positions. GEICO has done so well for so long that it is difficult to imagine its "battered" origins. In 1975, GEICO reported a loss of $7.13 per share, dropping its equity value from $8.13 to $2.08. This loss of about 75% of the net worth of an insurance company in 12 months is horrendous. During the following year, while GEICO was reporting another $1.51 per share in loss, Mr.Buffett began purchasing the stock at $3.18 per share. This price paid seems high (greater than book value) for a company teetering on bankruptcy.

The results were spectacular. During the following 20 years, Mr.Buffett's return on GEICO stock was 27.2% per year. He profited two-fold: the inherent high quality growth of the GEICO business and the deep discount he paid rose to its inherent worth.

Effects of WWII?

Keeping with the title of my blog - "random bits," I have included something for a future sociology paper. The "replacement ratio" for keeping a steady population is 2.1. The lowest replacement ratios of all developed countries are these three which are, coincidentally or not, the three major Axis powers of WWII. I guess if the quest for "lebensraum" was not going to be met with more territory, then perhaps a low birthrate could have the same effect.

Pension Problems

My first blog (January 2006) dealt with IBM's decision to freeze its pension plan, citing it as "significant." Here is a graph from the General Accounting Office (GAO) depicting the beginnings of tsunami-like wave approaching our shores. The GAO is tracking the underfuning in these PGBC-insured defined benefit plans. Given that such underfunding is based on generous assumptions (meaning that the underfunding is understated), the true size of the underfunding must be several multiples of this $500 billion - a truly frightening issue. Many more companies are going to need to follow IBM's lead.

GM's Challenges

At the beginning of 2006, I blogged about the investment opportunities for GM. Had I pursued it, the investment would have been excellent. But, it wasn't sour grapes that resulted in my year-end criticism of the management's deflection of Kirk Kerkorian's inputs. What he was attempting to fix, that Wagoner et al. are still in the throes of, is graphically illustrated here.

The structure of compensation creates significant differences between companies. GM pays cash compensation similar to Chrysler, but more than Ford, while paying benefits similar to Ford, but more than Chrysler. The net result is that GM pays out compensation per unit produced at a level roughly 25% greater than Ford or Chrysler pays out. This is only comparing GM to the domestic competitors; the contrast to foreign competitors is even more striking. Stay tuned; this will get really interesting.

What About Wal-Mart?

Wal-Mart (WMT) is a controversial investment. In earlier blogs, I have analyzed some of this controversy: the union-generated smear campaign and the powerful WMT grocery business that threatens those unions. Yet the controversy is aided by the lagging stock price.

2006 was a good year for WMT operationally, but the investment community's response was tepid. While the overall market moved up nearly 15%, WMT's stock did not move up at all. Making matters worse, WMT's stock price has hardly moved up since 1999 - nearly flat for eight years. During that period, WMT's sales more than doubled, moving from $165 billion to $340 billion. Net profits also more than doubled, moving from $5.7 billion to almost $12 billion. In fact, the only operating metric to not double was the number of stores, which increased by 80%. This means that same-store sales and same-store profits increased nicely. So why didn't the stock move up?

Part of the problem was an excessive beginning p/e ratio. At the beginning of the period, WMT's p/e ratio averaged 39. (For the uninitiated, price to earnings ratios give me nose bleeds when higher than 20. 39 is ear-bleed territory.) Another issue is a slowdown in WMT's growth rate. However, WMT has periodically had low growth rates. So a fair question is "what should WMT's p/e be?"

WMT retains 80% of its earnings to build and buy stores worldwide. 20% of the earnings is paid out as a dividend. The retained earnings should grow by roughly 7% per year. In addition, there should be growth to at least cover inflation at roughly 2% per year. Finally, there should be some "real" same-store growth in profitability of roughly 2% per year. This overall 11% growth rate does not include the dividend. Without getting too technical, such characteristics probably deserve at least a 25 p/e - much higher than today's 16 p/e.

After spending years defending those not purchasing WMT, it feels odd to experience a complete reverse. The same arguments that were used for purchase, e.g. largest retailer in the world, high quality culture, top-notch systems, no longer have an effect. The numbers are huge. Over 100 million Americans shop at WMT every week; over 180 million do it globally.