USFD - US Foods: Adopting A Wait-And-See Approach Until Q2 2023

2023-05-17 00:01:36 ET

Summary

• US Foods Holding exceeded market expectations in 1Q23, with impressive financial results.
• USFD has demonstrated significant improvement in gross profit per case, contributing to overall gross profit growth.
• Despite macroeconomic uncertainties, management maintains a positive near-term outlook.

Overview

US Foods Holding ( USFD ) is a food service distributor that serves a variety of industries in the United States. The results for USFD in 1Q23 were excellent once again. The positive 1Q23 results can be attributed to a number of factors. First, better-than-expected growth more than offset the effects of inflation, and a more profitable customer mix helped boost profits significantly. As things stand, I don't anticipate any problems with USFD's ability to reach its FY23 goal.

In addition to these factors, I think that the 1Q23 results show how crucial an exposure to healthcare and hospitality customers is to a company's overall customer mix, which has helped the USFD recover demand. This is both good and bad, as high inflation and possible high interest rates are likely to hurt demand, putting a damper on the sustainability of the current recovery. As such, I think a lot of investors in the market are holding a “wait and see” approach on how well USFD can execute in this environment. Importantly, if management can show both growth and improvement in margins, I believe this will cast a strong positive momentum on the stock valuation (forward P/E), pushing it back to the historical average (from 14.4x to 16.7x). My take is it is very possible for margin to expand given that a lot of the levers are in the hands-on management such as pricing and cost control. My recommendation on USFD stock now would be to wait for 2Q23 results to see how well the company is progressing to FY23 profit targets, and also assess management comments on the demand outlook for rest of the year.

1Q23 earnings and near-term outlook

In the first quarter, USFD delivered strong financial results, surpassing market expectations. EBITDA reached $337 million, beating the consensus estimate of $293 million, while EPS stood at $0.50 compared to the consensus of $0.40. Revenue showed a modest upside at $8.54 billion versus the expected $8.48 billion. Notably, growth in total case volume was impressive, reaching 5.7%, with notable strength in independent restaurant case growth at 8.1%, as well as solid performance in the hospitality and healthcare sectors at 18.8% and 5.9% growth, respectively.

Despite concerns about the lower-margin chain business, which experienced a decline of 1.1%, it was not as severe as anticipated, thanks USFD emphasis on independent growth. The gross profit margin per case of 16.9% contributed significantly to the total gross profit of $1.45 billion. Compared to the 5.7% increase in cases, this represents a significant 14% increase in gross profit year over year. This effectively showcased USFD ability to increase average pricing (via various means like organic price hike, vendor management, etc.) – which is an important lever to it achieving FY23 targets, in my opinion.

While the macroeconomic outlook is cloudy for the next few months, it is encouraging to see management be very upbeat about current demand and the near-term outlook. I anticipate further customer acquisitions and market share gains, especially among USFD target customer types like independent establishments, thanks to the recovery of the hospitality and healthcare industries. I also anticipate that the new online platform being rolled out as part of USFD's omni-channel and digital growth initiatives will contribute significantly to performance.

Margin upside

I think it is clear that margins have improved significantly and I believe there is still room for expansion this year. There are two key line item at play here: gross profit per case and operating expenses. As mentioned above, I believe USFD can continue to drive higher prices (pricing optimization, labor productivity, etc.) this year under the guise of inflation (despite it showing signs of coming down). Increase in pricing here has huge impact on the bottom line given the high incremental margins. That said, I acknowledge inflation will not stay higher forever, and disinflation might hurt margins.

However, what is noteworthy is that USFD's remarks drew attention to deflation in specific protein categories where a fixed dollar markup exists, safeguarding gross profit per case. Meanwhile, numerous other products are still experiencing inflationary pressures, and it is expected that overall inflation will persist. Even if gross profit per case erodes, I think USFD's success in driving company specific initiatives will help to cushion and decrease in gross profit via lower operating expenses (i.e. lower cost structure. Furthermore, although the extent of future leverage on the operating expense line is uncertain, the newly appointed CEO hinted at potential cost-saving measures that could lead to additional profit growth in the forthcoming years.

Conclusion

USFD delivered impressive results in 1Q23, surpassing market expectations with strong EBITDA and EPS figures. The company showcased robust growth in total case volume and gross profit per case. The near-term outlook remains positive, with management expressing confidence in current demand and future prospects, driven by the recovery of the hospitality and healthcare industries. While macroeconomic uncertainties persist, I believe USFD has the potential to further enhance margins through pricing optimization and cost control measures. The introduction of cost-saving initiatives by the new CEO also offers additional upside potential for profitability in the coming years.

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