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Why Sysco (SYY) Popped on Monday

Tickers in this article: KKR SYY

NEW YORK (TheStreet) -- Sysco Corporation  settled from earlier highs of over $40 following news it had agreed to purchase U.S. Foods in a deal with total enterprise value of around $8.2 billion.

By mid-afternoon, the food retailer and distributor was trading up 9% to $37.41.

Sysco agreed to pay $3 billion in cash and $500 million in stock and by close, equity holders of U.S. Foods will own 87 million shares, or 13% of the company. U.S. Foods' majority shareholders include affiliates of Clayton, Dublier & Rice and Kohlberg Kravis Roberts , a representative of each to join the Sysco Board of Directors after the deal's close.

The acquisition, expected to be finalized in the third-quarter of next year, will create a company with estimated combined annual sales of $65 billion and realize annual synergies of $600 million as early as 2017.

On a conference call Monday morning, Chief Executive said Sysco's current 18% share of the food distribution market will benefit from the addition of U.S. Foods' 9% share. 

Despite the creation of an industry powerhouse, Moody's Investors Service has placed all ratings of Sysco on review for downgrade due to its assumption of $4.7 billion of U.S. Foods' debt. 

"While Moody's believes the transaction makes strategic sense, and the pricing at around 10 times EBITDA seems reasonable given synergy potential, the immediate impact on Sysco's credit metrics from the debt component will result in a level of deterioration that will likely lead to a downgrade," explained Moody's Vice President Charlie O'Shea in a press release

TheStreet Ratings team rates Sysco Corp as a Buy with a ratings score of A-. The team has this to say about their recommendation:

"We rate Sysco Corp (SYY) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, increase in stock price during the past year, reasonable valuation levels and notable return on equity. We feel these strengths outweigh the fact that the company shows low profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The revenue growth came in higher than the industry average of 5.7%. Since the same quarter one year prior, revenues slightly increased by 5.7%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
  • The debt-to-equity ratio is somewhat low, currently at 0.60, and is less than that of the industry average, implying that there has been a relatively successful effort in the management of debt levels. Although the company had a strong debt-to-equity ratio, its quick ratio of 0.97 is somewhat weak and could be cause for future problems.
  • Compared to where it was 12 months ago, the stock is up, but it has so far lagged the appreciation in the S&P 500. Turning our attention to the future direction of the stock, it goes without saying that even the best stocks can fall in an overall down market. However, in any other environment, this stock still has good upside potential despite the fact that it has already risen in the past year.
  • Sysco Corp's earnings per share from the most recent quarter came in slightly below the year earlier quarter. The company has suffered a declining pattern of earnings per share over the past two years. However, we anticipate this trend to reverse over the coming year. During the past fiscal year, Sysco Corp reported lower earnings of $1.68 a share vs. $1.91 a share in the prior year. This year, the market expects an improvement in earnings ($1.86 vs. $1.68).
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