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Markets

The Wal-Mart of Food Service

Sysco, already hugely profitable, should thrive in an economic downturn.

At first glance, Sysco Corp. would seem like a stock to avoid in a weakening economy. The largest distributor in the food-away-from-home industry books nearly all of its sales in North America, currently a weak link in the global economy. Food inflation zoomed from zero at the start of 2007 to 6% during the year. High gasoline prices are squeezing restaurants, from which Sysco derives 64% of sales.

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But if you look deeper, you'll find a company with enormous strengths, built to weather hard times -- and even flourish in them. That's how Houston-based Sysco has boosted sales and dividends every year since it went public in 1970. "We tend to do better than our competition in tough times," says chairman and chief executive Richard Schnieders. He aspires to boost Sysco's market-leading share from about 15% to 25% over time.

The away-from-home food business in the U.S. and Canada is a $225-billion industry at wholesale. Sysco provides its customers with everything from food (fresh, frozen and canned) to paper products to kitchen equipment. Its roughly 400,000 clients include restaurants (most of them independent local operators), hotels, hospitals, schools and company cafeterias -- pretty much any place that prepares food. Major customers include Wendy's and Whole Foods.

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A glamorous business it isn't. But Sysco, built through more than 140 acquisitions, can turn a nice profit through scale, efficiency and a wide network of distribution centers across the U.S. and Canada. In the fiscal year that ended in June 2007, it earned $1 billion after taxes, or $1.60 per share, on sales of $35 billion. Revenues this year should approach $38 billion.

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A 3% net margin doesn't sound high, but that doesn't tell the profitability story. Sysco consistently generates a return on capital in excess of 20%, while its cost of capital is less than 10%. A business with those kinds of numbers creates enormous economic value for shareholders, year in and year out. That is reflected in Sysco's bountiful free cash flow (cash available after necessary capital spending) and impressive record of boosting dividends, which have compounded by 17% annualized over the past ten years. The company also achieves an unusually high return on equity (a measure of profitability) of more than 30%.

How does Schnieders intend to keep boosting profits and grabbing market share? First, Sysco is so indispensable to its customers that it has little trouble passing on increases in food prices to them. Schnieders says the company is drawing closer to clients through joint "business reviews," which typically include advice on menus and operating details, such as inventory control.

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Sysco is also strengthening its already potent, industry-leading network of 177 distribution centers -- more than twice the number of its largest competitor, privately held US Foodservice. It is building six regional redistribution centers that Schnieders says will dramatically improve efficiency in the supply chain. The concept, he says, is akin to Wal-Mart's logistics system and is unlikely to be replicated by Sysco's rivals. "Our network is so much bigger and more powerful than the competition, which doesn't have the systems to do it," he says.

Sysco will likely gain market share in a recession, but the stock is selling at recessionary prices. At $29 in mid February, Sysco (symbol SYY) traded at 16 times estimated 2008 earnings. That compares with an average price-earnings ratio of 23 over the past five years, says analyst Mark Churchill, of Piper Jaffray, and it's the lowest the P/E has been in the past decade. Plus, you get paid a 3% yield while you wait for the stock to appreciate.

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