Don’t Be Fooled Into Buying US Foods Stock

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USFD stock - Don’t Be Fooled Into Buying US Foods Stock

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The big news item for US Foods (NYSE:USFD) should have been its recently announced acquisition of five food-related businesses from Services Group of America. Valued at $1.8 billion, the deal provides US Foods a significant presence in the northwestern market. Unfortunately, it was the massive drop in USFD stock that captured almost everyone’s attention.

On Monday, US Foods shares hemorrhaged 17.5%. Anytime you lose double-digit percentages in the markets, it’s never a good moment. But this fallout was particularly ignominious for the food-distribution company because it was the worst single-day performance in its history. Before this, the worst performance occurred on Aug. 9, 2017.

The damage at that time? A much more modest 4.6% loss. The average of all losses not inclusive of Monday’s massive hit was 0.9%. While bearish analysts sometimes make a mountain out of a molehill, in this case, they’re right to sound the alarm on USFD stock.

Most of the pain stemmed from a disappointing second-quarter 2018 earnings result, which I’ll go into detail shortly. But in the immediate framework, USFD stock reversed almost all of the good work it did this year.

Prior to the Q2 earnings release, shares of US Foods were up nearly 27% year-to-date. After the fallout, USFD has gained less than 5% YTD.

The frustration is palpable because while specific names in the food and grocery markets produced mixed results, overall demand is very robust. Last year, grocery-store sales totaled nearly $612 billion. In any given year, these sales will increase annually by 1% or 2%. And aside from recessionary years, food distributors could count on consistent, albeit small growth.

That assumption now comes under serious inquiries due to the USFD stock price cratering.

Q2 Earnings Reveal Stunted Progress

To be clear, US Foods’ earnings results on paper weren’t terrible. For instance, prior to the Q2 report, the Street pegged consensus earnings per share at 58 cents. Individual estimates ranged from 55 cents to 60 cents. Actuals came in at 57 cents, which is less than a 2% miss.

That’s bad, but it certainly doesn’t justify a near 18% beat down in the markets. Nor does the revenue situation explain the fallout. Consensus aimed for $6.3 billion, with a range between $6.2 billion and $6.4 billion. US Foods delivered on the low end of the scale, or a 1.6% slip up.

Again, not great, but no reason to get out the pitchforks. What really scared off investors was case volume. This critical metric fell 0.9% in the quarter because large customers didn’t order as much product. That doesn’t bode well for USFD stock due to the razor-thin margins inherent in the food-distribution industry.

Last year, US Foods’ operating margins averaged under 2.4%. Net margins were 1.84%. True, the company isn’t a profitability leader against its peers, but consider that in the global-food distribution sector, the median operating margin is currently 2.9% while net margin is just under 2%.

In other words, a miss in case volume is a huge deal because few, if any, opportunities exist to make it up elsewhere.

Even worse was the guidance. Management previously anticipated 1% case-volume growth this year as compared to 2017. Now, execs downgraded their expectations, indicating that volume will be roughly the same as last year.

The conference call mentioned some negative impact due to operational miscues involving late-inbound trucks. Management believes they can solve this issue by hiring more and better truck drivers. Even here, the company faces severe headwinds due to unprecedented driver shortages.

Is USFD Stock Worth It? The Markets Emphatically Say No!

Long story short, USFD stock tanked because the underlying company has been hit with pressure from all angles. As a result, US Foods recent acquisition looks like an overly risky gamble. Even management admitted that they won’t see an earnings benefit until the second year after the deal closes.

But for me, USFD stock suffered its historic collapse because it can no longer justify its rich market premium. Before Q2 devastated shares, the food distributor gained 68% over the trailing two-year period. That’s acceptable if the company delivers robust growth. Obviously, confidence has quickly soured.

In some situations involving severe volatility, contrarians encourage buying the blood on the streets. My two cents? Don’t. Sometimes, market participants can be irrational. However, with USFD stock, sellers are being very much rational. The blood you end up buying could be your own.

As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare. Tweet him at @EnomotoMedia.


Article printed from InvestorPlace Media, https://investorplace.com/2018/07/dont-be-fooled-buying-usfd-stock/.

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