USFD - Performance Food Group: Ranking Against Its Competitors

2023-08-13 11:27:20 ET

Summary

• The food distribution industry offers investment opportunities despite its challenges, as people will always need to eat.
• Performance Food Group has outperformed its competitors in terms of returns and revenue growth turbo charges through acquisitions.
• However, the company lags behind its competitors in terms of operating and gross margins, and its stock is currently overvalued compared to industry peers. A hold rating is recommended.

It is no secret that the Food distribution industry is a tough business to be in. Tough businesses make for tough investments but it doesn't mean that it should be overlooked. Even in the face of adversity, the industry can offer a recipe for success. We have seen this in the last few years when the demand was resilient. Regardless of economic cycles, pandemics, consumer preferences, or global uncertainties, people need to eat. The industry serves a diverse array of sectors, from restaurants and fast food to packaged foods and delivery services and this diversity offers investors a multitude of entry points. While the industry itself might experience fluctuations and changing consumer preferences, the fundamental need for sustenance ensures its permanence, making it an attractive option for investors. But due to the inherent challenges associated with the industry, it is key to invest in a company that ranks the best in the group. Against a basket of Food Distribution industry stocks, Performance Food Group ( PFGC ) has had the best performance in the last few years but can we still make the case for investment in this company?

In the last five years, Performance Food Group has returned 64%, comfortably more than twice the next-highest returns offered by US Foods Holding Corp. But this is still less than SPY which has returned close to 71% over the same time period. This clearly suggests that this industry is indeed a tough business to be in and to make money for the investors.

Challenges plaguing the industry

Before we see if we can make the case for Performance Food Group, it is key to understand the challenges that are ever present in this industry. Understanding these challenges would help us grasp the full picture of the company.

1. Low-Profit Margins: The food distribution industry often operates on thin profit margins due to intense competition, price sensitivity among customers, and the necessity to handle perishable goods efficiently. This can limit the potential for substantial profitability.

2. High Operating Costs: Operating costs in the food distribution sector can be substantial, including expenses related to storage, transportation, refrigeration, and compliance with stringent regulations. These costs can eat into profits.

3. Supply Chain Complexity: Managing a complex supply chain with various suppliers, distributors, and retailers requires efficient logistics and inventory management. Disruptions in the supply chain can impact the timely delivery of goods and increase costs.

4. Volatility Food Costs: Fluctuations in the prices of products, such as agricultural products, can impact the cost structure of food distribution companies. These price changes can be difficult to predict and manage.

5. Regulatory Compliance: The food distribution industry is subject to strict health, safety, and quality regulations (Ex: From USDA and FDA). Non-compliance can lead to legal issues, recalls, and reputational damage.

6. Seasonal Demand: Food consumption patterns can be seasonal, leading to fluctuations in demand throughout the year. This can affect the bottom line through increased operational planning.

7. Competitors: The industry is highly competitive, with numerous players ranging from local suppliers to large national distributors. Smaller players often align themselves with other smaller distributors through purchasing cooperatives and marketing groups. Competition can drive down prices and erode profitability.

8. Changing Consumer Preferences: A great example would be consumer preferences evolving toward healthier and more specialized foods, distribution companies may need to adapt to these changes, which could involve additional costs.

The players

There are a few listed prominent players with the biggest overlaps in the business model with Performance Food Group. It has competitors in a wide range of sizes in terms of market cap and revenues. But all companies in this industry face similar challenges so it is important to see how well they are all faring and how this is reflected in their bottom line. For comparison, we will review them over the years which would also give us an idea if things have been getting better or worse over time.

What has contributed to its rise?

In my opinion, the biggest factor that allowed the Performance Food Group to leapfrog its returns over its competitors is that its acquisitions have continuously allowed it to grow and increase its size. PFG’s largest acquisition to date was in 2021 when it acquired Core-Mark Holding Company for $2.5B. This acquisition alone contributed $14.5 billion of net sales in fiscal 2022.

Performance Food Group clearly had the highest jump in the last four years when comparing the revenues. From 2019 to 2022, the revenues moved from $19.7B to $47B. While Sysco has reported the highest revenues in 2022, the jump is just 14% compared to a more than 100% jump for Performance Food Group. While this has been enough to contribute to the rise in stock price, we have to check the underlying and see if it can sustain its current level. It is key to understand where the company leads or lags against its competitors.

Trailing its competitors

Reviewing its margins against its competitors there are a few key observations:

• There are multiple companies outperforming Performance Food Group with respect to Operating Margins and Sysco Corporation consistently ranks above the rest of the companies
• Performance Food Group consistently lags behind all of its competitors with respect to Gross margins and Chef's Warehouse takes the crown for all the years.
• The situation has not improved much if we consider the LTM data. Operating margins for LTM stand at 1.2% and Gross margins for LTM again stand close to 11%

Financial Health

It was surprising to see that while Performance Food Group was able to juice up its revenues through acquisitions, it still has a long way to go in terms of margins and profitability. So I was curious to check if there was consolation in terms of its debt when compared to its equity. Although it won't give us the full picture in terms of financial health, it will at least tell us what levers the company can still pull where others would have a tougher time doing so.

It is a welcome sign to see that Performance Food Group is in a relatively much better debt position when compared to its peers. At a Debt to Equity ratio of 0.98, even after all those acquisitions the company has a good hold on its balance sheet and can use this to improve its operations. But it has to be noted that other companies are not far behind and this advantage can be quickly lost if Performance Food Group does not maintain a tight ship.

Valuation

I am picking two metrics for comparison here. First of all, I would like to understand how well the company is trading with respect to its earnings but more importantly, I would also like to assess whether the company's stock price is reasonable in relation to its cash flow. Assessing different companies within the same industry through this metric helps us gauge which companies are generating stronger cash flows relative to their stock prices, crucial for sustaining their operations and supporting growth. Additionally, it is helpful when evaluating companies with varying levels of depreciation and amortization.

Performance Food Group ranks fourth in this list for PE multiples and fifth in terms of P/CF multiples. This suggests that the company is overvalued when compared to the basket of Food Distribution stocks. Currently, I believe the market is willing to pay a premium for this stock based on its prospects. As we saw its acquisitions have helped boost its top line and these acquisitions may also help the company achieve synergy and unlock efficiencies there by boosting profitability. But the problem here is that the industry's challenges are hard to navigate and going forward the stock may underperform if the company is not able to boost its profitability and cash flows.

A Hold Rating

The point of this write-up is to not only understand what has helped Performance Food Group outperform its competitors but also to elaborate that this outperformance may not last long if the company does not tighten its belt in certain areas. But as we saw from the challenges to this industry, it could be easier said than done. While acquiring competitors is relatively easier and could be achieved through the use of capital, the next part where the company is actually able to realize the benefits of this acquisition and get a leg over its competitors is tougher than most investors expect. Presently, the current valuations expect the company to realize these benefits. In a situation where the company is not able to fully leverage the benefits, the stock may underperform in the future. Rating PFGC stock as a Hold for now and I will be keeping a close eye on this stock for the future. If the company is able to display strength in its bottom line, I will consider revisiting my thesis.

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