May 8, 2017

SYY’s Uniform Adjusted EPS’ is growing far more slowly than reported, warranting downside


  • SYY’s profitability is materially distorted by accounting depreciation
  • As such, their EPS’ is expected to grow by 16% next year, not 29%
  • After making the appropriate UAFRS adjustments, SYY is trading at a 23.7x Uniform P/E, or a 2.0x PEG, suggesting EPS’ growth does not support currently aggressive valuations

 

Sysco Corporation (SYY) is expected to report Q3 EPS of $0.49 on 5/8, representing 29% growth over $0.38 levels in the same period last year. Full year estimates are similarly aggressive, and are for EPS’ growth of 36% next year, from $1.84 in the four quarters ended Q2 2017, to $2.50 in the next four quarters. Continued optimism surrounding the firm’s growth prospects has driven material share gains, with over 30% returns since the beginning of 2016.

However, after making appropriate adjustments under Uniform Accounting Financial Reporting Standards (UAFRS), it is apparent that profitability growth at SYY is actually far slower than as-reported, and valuations are more aggressive, suggesting the recent run in price was unwarranted.

Specifically, under UAFRS, Uniform EPS (EPS’) is actually only expected to grow by 4% in Q3, from $0.49 in Q3 2016 to $0.51. Moreover, full year growth is only expected to reach 16%, not 29%, with EPS’ expected to grow from $2.22 in the four quarters ended Q2 2017 to $2.58 in the next four quarters. Investors may not realize the more bearish outlook for SYY, and at current valuations, which are higher than as-reported metrics would suggest, this implies downside may be warranted.

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The quarterly results show a similar trend, with EPS’ growing more slowly than as-reported metrics suggest, and although EPS’ is greater-than-reported, slowing growth does not support current valuations. As such, longer-term underperformance, or even downside may be warranted.

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UAFRS, Uniform Adjusted Financial Reporting Standards, calls for removal of distortions from issues like the treatment of excessively aged, or relatively long-lived assets. Once removed, it is apparent that EPS’ is growing more slowly than as-reported, at a rate that would not support current valuations.

UAFRS vs. As-Reported EPS

Investors make major decisions about which companies to own based on quarterly company earnings, the most common metric mentioned in traditional corporate investment analysis.

However, more often than not, the earnings that companies report in any given quarter can swing wildly and lead investors to completely wrong conclusions, because GAAP and IFRS rules force management to report results in ways that are not representative of the real operating performance of the business.

While there is a case to be made that some management teams can use “creative accounting” to adjust numbers, the research would show that more often than not, the real problem is with the accounting rules themselves, not management’s use of them.

Impact of Adjustments from GAAP to UAFRS

There are several adjustments required to make earnings representative of a firm’s true cash flows. For SYY, the most material is related to adjusting for true depreciation of the firm’s assets.

Given the long-lived nature of SYY assets, the true maintenance capex costs related to their assets is much higher than depreciation, which is reflective of the cost of those assets when the company bought them, which happened almost 10 years ago for many of SYY’s assets. As such, nominal asset values should be restated into constant-currency values to improve the reliability of business performance metrics, and the related depreciation (maintenance capex) expense should then be calculated off of the value of the Adjusted Asset base.

UAFRS-reporting adjusts for these traditional accounting distortions by estimating the age of assets and using a GDP deflator to adjust the asset value and associated depreciation expense into the values reflective of what replacement cost would be in the current year being measured. This simple adjustment removes a tremendous amount of accounting noise related to investment activities and improves investors understanding of the operating earnings of a business.

Worse-than-reported growth indicates SYY valuations are overly aggressive

At current prices, SYY is trading at a 20.3x as-reported forward P/E, suggesting the firm is trading around corporate averages, and is cheap when considering expected growth rates, even after the run in share prices in the past year. However, after making the requisite adjustments, it is apparent that SYY is actually far more expensive, and considering expected growth rates, is significantly overvalued.

Specifically, the firm is actually trading at a 23.7x UAFRS-based P/E (P/E’), which is above corporate averages. Given expected long-term EPS’ growth rates of 11%, SYY is currently trading at a 2.1x PEG ratio, indicating a firm that is overvalued, and longer-term underperformance is likely warranted.

By using Uniform Adjusted Financial Reporting Standards (UAFRS), investors see a cleaner picture that distorted GAAP and IFRS metrics cannot show. By standardizing financial reporting consistently across time and across companies, corporate performance and valuation metrics improve dramatically. Comparability of a company’s earnings over time, trends in corporate profitability and comparability in earnings power and earnings growth across close competitors and different sectors becomes far more relevant and reliable.

To find out more about Sysco Corporation and how their performance and market expectations compare to peers, click here to access the open beta of the Valens Research database.

Our Chief Investment Strategist, Joel Litman, chairs the Valens Research Committee, which is responsible for this article. Professor Litman is regarded globally for his expertise in financial statement analysis, fundamental research, and particularly Uniform Accounting, UAFRS.