USFD - US Foods Holding Corp.: A Tasteless Mistake

Summary

• US Foods Holding Corp. has continued to do incredibly well, especially in what is admittedly a difficult environment.
• Current guidance implies that this will continue, much to my surprise.
• This has caused me to re-evaluate my own stance on the business, resulting in the conclusion that my prior assessment was wrong.

Although I am a professional investor, even I make more mistakes than I would like to admit. The most painful mistakes are those that result in capital losses, the second most painful are those that result in missed opportunities. One really great example of the latter involves a company called US Foods Holding Corp. ( USFD ). For those not familiar with the company, its entire operation is dedicated to distributing food and related products to roughly 250,000 customers across the US. Fundamentally speaking, the firm has done quite well in recent years. Even so, I underestimated the kind of upside that the business offered to shareholders. After careful consideration and a re-evaluation of the business, I do think that some additional upside is still on the table. Because of that, I have decided to rate it a soft 'buy' at this time.

Just deserts

Back in November of 2022, I revisited US Foods to see whether or not the company made sense for investors to consider. At that time, the firm was continuing to generate attractive revenue and profit growth year over year. Ultimately, I felt as though it was a great company, but shares were not cheap enough to justify a 'buy' rating. Ultimately, this meant that I assigned the company a 'hold', which is a rating that reflects my view that shares should generate upside or downside that would more or less match the broader market moving forward. In retrospect, I terribly underestimated the business. You see, while the S&P 500 is up 2.9% since the publication of that article, shares have generated upside for investors of 11.6%. And since first rating the company a 'hold' back in June of last year, the stock has seen upside of 39.1% compared to the 8.1% rise the broader market experienced over the same window of time.

Such upside, particularly in a difficult market, is painful to have missed. But the good news is that, in my opinion, shares probably now do offer some additional upside potential from here. To see what I mean, we need only look at data covering the final quarter of the company's 2022 fiscal year. This is the most recent quarter for which data is available. According to management, revenue came in at $8.52 billion. That's 11.5% higher than the $7.64 billion generated one year earlier. 8.4% of the sales increase, according to management, was driven by food cost inflation that the enterprise passed on to its customers. Even in spite of this rise, the company reported total case volume that was 2.6% higher than it was one year earlier. This was driven, in turn, largely by a 5.8% increase in independent restaurant case volume, a 19.2% increase in hospitality volume, and a 5.6% increase in healthcare volume. Volumes would have been even higher had it not been for a 1% impact associated with the company's decision to strategically exit a small number of low-margin chain restaurant and education customers. It is worth noting that the company actually missed expectations set by analysts to the tune of $20 million for the final quarter.

The rise in revenue brought with it improved profits as well. Net income, for instance, shot up from $69 million in the final quarter of 2021 to $93 million in the final quarter of 2022. Although this was nice to see, it becomes even better to see when you consider that earnings per share of $0.37 beat out analysts' expectations by $0.01 per share, while adjusted earnings per share of $0.55 came in higher than what analysts expected by $0.02 per share. Operating cash flow went from negative $101 million to positive $152 million. Even if we adjust for changes in working capital, it would have risen nicely, climbing from $191 million to $233 million. And finally, EBITDA for the business rose from $262 million to $350 million.

The same themes the aid of the company in the final quarter of 2022 were instrumental in pushing results for the 2022 fiscal year in its entirety up compared to what the company experienced one year earlier. From 2021 to 2022, revenue shot up from $29.49 billion to $34.06 billion. That's an increase of 15.5%. During this time, net income jumped from $164 million to $265 million. Operating cash flow expanded from $419 million to $765 million, while the adjusted figure for this grew from $649 million to $722 million. And finally, EBITDA for the business popped higher from $1.06 billion to $1.31 billion.

Now that the 2022 fiscal year is over, management has provided some guidance for 2023. Despite broader economic concerns, they anticipate EBITDA of between $1.45 billion and $1.51 billion. They also think that adjusted earnings per share will be between $2.45 and $2.65. At the midpoint, that would translate to adjusted net income of $641 million. No guidance was given when it came to other profitability metrics. But if adjusted net income looks similar relative to GAAP net income in 2023 like it did in 2022, then we should anticipate a reading of $316 million. By my estimate, adjusted operating cash flow should come in at around $816 million.

Based on these figures, US Foods is trading at a forward price-to-earnings multiple of 28.1. The adjusted multiple should be substantially lower at 13.9. Normally, I don't like to use adjusted earnings figures. This is especially true when things like stock-based compensation are included in the picture. But in this case, a large portion of the disparity involves a LIFO reserve adjustment that makes sense to factor in. The forward price to adjusted operating cash flow multiple should come in at 10.9, while the EV to EBITDA multiple should come in at around 9.5. In the chart above, you can see pricing using data from both 2021 and 2022 as well. For the purpose of my analysis, I will focus more on the 2022 fiscal year. In the table below, I used that data and compared it with five similar firms. On a price-to-earnings basis, these companies range from a low of 11.1 to a high of 52. And when it comes to the EV to EBITDA approach, the range would be from 5.9 to 15.3. In both cases, three of the five companies were cheaper than US Foods. Finally, using the price to operating cash flow approach, the range was between 5.4 and 62.7. In this scenario, only one of the five companies was cheaper than our target.

Takeaway

Based on the data provided, I must say that US Foods continues to chug along nicely. Sales, profits, and cash flows have both risen and are on the path to continue rising. The company may not be the cheapest player in the market, especially relative to similar firms. But I do think that I underestimated its potential and, as a result, missed out on a really good opportunity. I do think that shares are cheap enough to warrant some additional upside from here, but it's certainly not going to be a tremendous amount compared to what the company has already seen. All things considered though, it is high enough, I believe, to warrant a soft 'buy' rating at this time.

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