USFD - US Foods Holding: Coming To Life Again

2023-05-23 11:11:14 ET

Summary

• US Foods Holding Corp. has seen a modest earnings recovery in 2021 and 2022.
• The outlook for 2023 looks solid as leverage comes under control, resulting in some cash flows to finance bolt-on deals as well.
• While the situation is a lot more compelling than it was at previous occasions at $40 per share, I am still not buying US Foods Holding Corp. shares here.

In the spring of 2021, I called shares of US Foods Holding Corp. (USFD) a reopening trade. As the company announced a sizeable acquisition which coincided with the start of the pandemic, investors were left rightfully nervous.

Amidst tough operating conditions, the company essentially managed to post breakeven results, which given the circumstances was a decent result. Amidst high leverage, investors were clearly hoping and anticipating a reopening of the economy, badly needed to provide some comfort. Investors were clearly anticipating this, as shares had made up all the lost ground.

A Recap

In March 2020, when the pandemic was on the verge of breaking out in a major way, US Foods Holding Corp. announced a $970 million deal for Smart Foodservice Warehouse, a cash and carry store business.

This deal was set to add over a billion in sales and $85 million in EBITDA, yet it came at a price as leverage would increase to 4 times EBITDA as well, not a great outlook given the pandemic being in its early innings. While food was a defensive category for such an environment, the company is a key supplier to restaurants, creating real risks and pressure on the business those days.

The contribution of Smart was relatively limited, as the company had just posted its 2019 results, revealing a $25.9 billion revenue number and $1.19 billion in EBITDA. With adjusted earnings pegged at $2.38 per share, or $2.23 per share if we back out stock-based compensation ("SBC") expenses, valuation multiples looked reasonably fair at 18 times earnings.

Pre-pandemic, the company guided for earnings around $2.70 per share for 2020, or likely around $2.50 per share if we back out stock based compensation expenses.

The $40 stock pre-pandemic traded in their teens in March of that year but had recovered to the $40 mark by May 2021. After seeing second quarter sales in 2020 being down as much as 30%, things improved sequentially as sales declines levelled off in the second half of the year, while the company was able to post flattish (adjusted) earnings, although that leverage ratios increased a lot.

Furthermore, first quarter sales for 2021 were essentially flat, as the company managed to maintain (adjusted) profitability. With earnings power likely coming in around $2.50 per share in a normal environment, it was the relative resilient share price performance and high leverage situation which made me very cautious to get on board at $40 in spring, not seeing a compelling risk-reward proposition.

Caution Prevails

In the two-year period since urging this cautious tone, US Foods Holding Corp. shares have largely traded in a $30-$40 range, now trading hands at $41 and change. While shares trade at their highest levels for a while, investors have not seen any capital gains over the last two years on a net basis.

After the business had recovered sales to $29.5 billion in 2021, sales rose further to $34.1 billion in 2022, aided by inflationary trends as well of course. Full year operating earnings rose to $594 million, and while growth outpaced top line sales growth, margins remain tiny at 1.7% of sales. The company grew adjusted earnings by 38% to $2.14 per share, but that still trailed pre-pandemic earnings power, of course. Adjusted for stock-based compensation expenses, these earnings came in at just below $2 per share. Amidst an improvement in profitability, US Foods reported a 3.5 times leverage ratio based on $4.6 billion in net debt and a $1.3 billion EBITDA number being reported.

The company guided for a further profit recovery in 2023, with EBITDA seen at a midpoint of $1.48 billion, adjusted earnings between $2.45 and $2.65 per shares, as this should push leverage ratios below 3 times by year end. That is welcomed as interest expenses totaled a run rate of $300 million by the fourth quarter, amidst higher interest rates. While the 2022 performance was actually disappointing, and makes it easy to understand why shares have been lagging, the 2023 outlook provides reasons to become somewhat more upbeat.

The company was off to a very strong start to 2023, as became evident early in May. First quarter sales rose more than 9% to $8.5 billion, with operating earnings rising from $34 million to $187 million, marking incredible leverage (on a GAAP basis). Most of this comes from a much lower LIFO reserve adjustment with inflationary pressure subsiding, although adjusted earnings rose from $0.36 per share to $0.50 per share.

With net debt ticking down to $4.5 billion and EBITDA improving to $1.4 billion, leverage ratios fell to 3.2 times, marking real progress on that front. Based on a basic share count out of 226 million shares, the company commands a $9.3 billion equity valuation at $41 per share. This values US Foods at nearly $14 billion on an enterprise basis.

Just after the release of the first quarter earnings release, US Foods announced the acquisition of New York-based Renzi Foodservice. The deal should contribute about $180 million in revenues, about half a percent on a pro forma basis. While no further financial details have been announced, it likely is a small deal in terms of the purchase price, as US Foods itself trades at just over 0.3 times sales.

And Now?

With realistic earnings trending around $2.40 per share here, US Foods Holding Corp. multiples have fallen to about 17 times forward earnings, while leverage has come down a bit. Nonetheless, I understand why shares have not moved up over this period of time. This comes as the 2021 and 2022 performance has been softer than I expected, and while 2023 is setting up to be a decent year, I am discounting the valuation on the back of lack of execution.

That said, US Foods Holding Corp. leverage is now coming under control, allowing for room to make some bolt-on deals after it was quiet on that front for three years. Some initial buybacks have been delivered upon as well. Amidst all this, I see US Foods Holding Corp. shares trading at fair value here. While the situation is a lot more comfortable than was the case early in 2021, and appeal is gradually improving, I lack conviction to buy US Foods Holding Corp. shares here.

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