Comments on Sysco and AFLAC

I expressed surprise and confusion at the market’s poor reception of Sysco‘s ($SYY) earnings. One reader provided some valuable insight:

Looking at the current quarter:

1. The gross margin (-76 basis points) was much weaker than expected. Company now chasing volume with lower pricing. A company not being able to raise prices in line with inflation always a bad sign.

2. 7.1% SG&A growth was too high, especially since Business Transformation costs were lower than expected.

Looking to the future:

1. Lowered business transformation cost estimates (but still increasing) for 2012 are not a true savings because it appears they are essentially just being pushed out to 2013.

2. Here is the biggie: Likely stagnant EPS for both 2012 and 2013 around $1.90-$2.00 per share. This is a 15 P/E for a company in a low-growth industry (future organic case volume growth likely in 1% to 2% range). Contrast that with numerous companies with P/Es in 10 area and with reasonably predictable growth potential in the 12-15% range.

I’m afraid the last point is probably correct. Outside of its dividend, Sysco doesn’t have much to offer investors right now. In fact, the dividend is probably what’s keeping a floor on the stock.

One day after I criticized Seeking Alpha for running little more than stock screens in words as its articles on AFLAC ($AFL), there appeared a thoughtful piece on it. Here’s a sample:

Aflac’s outsized portfolio of European financial hybrid securities is oddly a function of its exposure to the Japanese market. Given the absence of much Japanese government debt beyond the ten-year maturity, there is a limited long duration corporate bond market in Japan. Given the long duration liability profile of its Japanese business, and Aflac’s desire to match the duration of its assets and liabilities to immunize the portfolio against interest rate risk, Aflac flocked to yen-denominated perpetual preferred stock placed by financial institutions around the world. By hoping to reduce its risk profile through better asset-liability matching, Aflac unwittingly exposed itself to a potentially debilitating amount of credit risk.

This exposure to European financials led Aflac to recently bring in Eric Kirsch from Goldman Sachs Asset Management to lead its investment process, functionally demoting former head Jerry Jeffery to head of fixed income. The insurer has also continued to pare down its European financial exposures as markets have come off their autumn lows, and indicated on its recent earnings call that it would continue to try and work through issues in its investment portfolio.

While Aflac may prove to be cheap on the basis of its continued strong operating earnings, its low valuation relative to its book value or dividend stream, the dispersion of outcomes on the stock is too wide to know if the price is currently discounting this risk correctly. Aflac relies on dividends from its Japanese operating subsidiary to pay those shareholder dividends. Whether the Japanese regulators allow Aflac to continue to upstream capital from its Japanese operating company to the holding company will depend on the performance of its European financial hybrids.

If you are concerned about the European situation, Aflac is not the investment for you, and despite its continued efforts to right-size these exposures, this will be an ongoing process and will lower future earnings as Aflac is forced to reinvest the proceeds in a low rate environment. If you think we are at an inflection point in the Eurozone crisis, and see markets stabilizing, then Aflac is likely to see its equity rebound. Just know that in an odd twist of fate, the European credit markets will be the central driver of AFL’s equity performance in 2012.

Posted by on February 7th, 2012 at 5:32 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.