Description

Thesis:

US Foods shares have ~50% upside. USFD is well positioned within the highly fragmented food distribution industry, either as a consolidator or acquisition target.

Background:

US Foods is the second largest foodservice distributor, in most categories, behind Sysco. It was part of Royal Ahold until it was carved-out by Clayton, Dublier & Rice and Kohlberg Kravis & Roberts in 2006 and IPOed in 2016.  Sysco attempted to purchase the Company in 2014-2015.  The deal was blocked by the FTC. 

The food distribution business is highly fragmented with the top 3 players controlling only 40% of the overall market.  Sysco controls 15-20% of the market while US Foods has ~8% of the market. The industry, in aggregate, is growing at a rate just below GDP growth.  Consolidation and market share gains by large players are likely to continue, benefiting US Foods and other large peers.  Historically, this has been evidenced in higher revenue growth rates for Sysco and US Foods.

Valuation/Business Levers:

US Foods shares are worth ~50% more than current prices.  This would imply that the Company is valued similarly to Sysco on an EV / Sales basis.  On an absolute valuation basis, this would imply a normalized unlevered free cash flow yield of ~5%.

While comp valuations are often suspect, I believe it a valid anchor given Sysco’s attempt to buy the Company and US Foods’ demonstrated track record of margin improvement.  US Foods continues to close the margin gap relative to Sysco with operating margins having doubled over the past 5 years.  There is additional runway for US Foods as operating margins are only 60% those of Sysco’s. 

The key levers to margin improvement are personnel, private brands, and a focus on independent restaurants/chains. 

On the personnel front, US Foods has cut its sales rep headcount by ~1/3 over the past five years while still driving above industry revenue growth.  There are likely more workforce efficiencies to be had given industry and technological trends. 

Private brands (aka store brands, private label) have gained market share and are likely to continue doing so.  For US Foods, private brand volumes garner 70-120% higher margins than manufacturer brands.  The Company has increased its private brand revenue mix by ~1% per year for the past several years and likely has an opportunity to increase the mix by 5-10% over the next 5 years. 

Independent restaurants and small chains, which have been a core focus for US Foods, are a higher margin client for food distributors.  While independents are growing faster than other end markets, they are under pressure from competition, increasing labor costs, and technology among other things.  This creates an opportunity for US Foods and other distributors to provide tools to independents seeking out efficiencies. 

While difficult to value, as an acquisition target, US Foods could garner a premium to base case valuations for its strategic value.  There are 2 food distributors with a national footprint – Sysco and US Foods.  Obviously, Sysco saw the strategic value.  Amazon bought Whole Foods arguably for its expertise and distribution network in fresh products (negative comps certainly were not an attraction) despite being one of the most logistically savvy companies in the world.

Risks:

Competition from SYY

Labor costs

Catalyst

Additional stock buybacks

Potential acquisition