Fitch Ratings has affirmed the ratings for Sysco Corporation (Sysco) and Sysco Canada, Inc., including the Long-Term Issuer Default Rating (IDR) at 'BBB' and Sysco's Short-Term IDR at 'F2'.

The Rating Outlook has been revised to Stable from Negative.

The Outlook revision to Stable reflects Fitch's increased confidence that Sysco is well-positioned to experience share gains and grow at above industry rates. The Outlook stabilization also reflects the company's strong competitive position, buoyed by actions taken during the past two plus years to improve supply chain and sales capabilities that results in expectations for FY 2023 (July 1) EBITDA above the mid $3 billion range.

Fitch expects Sysco will demonstrate consistent capital allocation priorities by investing in the business, including bolt-on M&A and returning value to shareholders while maintain leverage within its stated net leverage target of 2.5x to 2.75x. This roughly equates to Fitch's leverage (lease-adjusted debt to EBITDAR) of 3.0x to 3.25x. Fitch projects leverage of around 3.2x in FY 2023, compared to about 3.3x in FY 2022.

Key Rating Drivers

Initiatives Driving Share Gains: Sysco's on-going strategic investments and initiatives during the past few years across the supply chain and salesforce are driving meaningful improvements in its competitive position relative to peers. According to the company, Sysco grew at around 1.3x the U.S. market in FY 2022 and is targeting to grow at 1.35x in FY 2023 and 1.5x in FY 2024.

Initiatives include new pricing software, enhanced restaurant service model, improved supply chain flexibility, team-based selling and upgraded digital platform combined with operational efficiencies. Additional efforts in the early stages that should help support further share gains supporting top-line growth and improved profitability over the next couple of years include: an omni-channel fulfilment system, Sysco Your Way initiative targeting local restaurants in high density locales and expansion of specific cuisine solutions.

Managing Supply Chain/Inflationary Pressures: Costs pressures around commodity inflation including 15% in the U.S. Broadline operations, fuel, increased spending for snapback, productivity, transformation and other initiatives, along with supply chain labor and product availability shortages impacted profitability during FY 2022. Despite these pressures, gross profit dollars per case grew in all four Sysco segments as volumes recovered, a consistent trend during FY 2022, as Sysco passed through product inflation along with a portion of the operating cost inflation. Sysco also benefitted from on-going cost-out efforts that have exceeded the company's $750 million target during the past three years.

With the on-going business recovery from the pandemic and benefit from strategic initiatives, U.S. broadline case volumes increased 18% on a comparable 52-week basis that helped support total sales and EBITDA growth of 34% and 50% to approximately $68.6 billion and $3.4 billion, based on Fitch adjustments, respectively in FY 2022.

$3.7 Billion EBITDA Projected: In FY 2023, Fitch projects sales and EBITDA could increase in the low double digits approaching $77 billion and around $3.7 billion respectively from inflationary pricing, further volume recovery in segments impacted by the pandemic, benefits from growth-related initiatives and improved efficiencies. The second half of FY 2023 could see a greater benefit from normalization in some of the supply chain related issues, progress from growth initiatives, improvement in labor productivity and lapping of Omicron-related effects.

However, given growing global macroeconomic pressures and uncertainty from unprecedented inflation, tightening monetary policies and evolving consumer spending patterns, lower EBITDA growth relative to Fitch's forecast remains a risk.

Consistent Capital Allocation Priorities: Fitch expects Sysco will demonstrate consistent capital allocation priorities by investing in the business, M&A and returning value to shareholders through increasing dividends and share repurchases while maintain long-term leverage within its stated net leverage target of is 2.5x to 2.75x, which roughly equates to Fitch's leverage of 3.0x to 3.25x assuming cash levels of around $800 to $900 million.

Sysco's core acquisition strategy has generally targeted smaller bolt-on transactions of distributors focused on higher margin specialty produce or geographically oriented distribution that better fills a stretched area or new white space opportunities. During FY 2022, Sysco closed on four bolt-on acquisitions totaling $1.3 billion including Greco and Sons, a leading independent Italian specialty distributor that enables a new cuisine-focused selling platform that Sysco is expanding to other geographies.

Low-3.0x Leverage Expected: Leverage was around 3.3x at FY 2022 compared to 5.1x in FY 2021 and 5.9x in FY 2020 and 2.8x in FY 2019. The improvement was driven by around $3.5 billion in debt repayment using excess liquidity that Sysco amassed during the coronavirus pandemic along with EBITDA recovery back to FY 2019 levels. Based on Fitch's projections, leverage is expected around 3.2x in FY 2023 reflecting additional EBITDA growth and relatively stable debt levels absent material M&A.

Leading Market Position: Sysco is the largest U.S. diversified foodservice firm in the food-away-from-home market with extensive geographic distribution. Sysco's scale provides significant cost efficiencies and enhances purchasing power with its suppliers. Sysco maintains a diversified customer base with the majority of revenues derived from restaurants of all types across independent and national businesses that helps to insulate the business from shifts in consumer spending. Sysco's remaining 37% of revenues are derived from healthcare, education/government, travel/leisure and other customer types.

Sysco's operating strategy targets increasing wallet share by balancing price and focusing on a broad range of one-stop services to drive growth in higher-margin local cases including a focus on increasing Sysco-branded product penetration. Sysco's wallet share with existing customers is around 30%, which the company expects to increase over time due to share gains supported by improved capabilities through its service model, supply chain and broad-based sales initiatives like Sysco Your Way.

Parent Subsidiary Linkage: Fitch's analysis includes a strong parent/weak subsidiary approach between Sysco and its subsidiary, Sysco Canada, Inc. Fitch assesses the quality of the overall linkage as high, resulting in an equalization of IDRs across the corporate structure.

Derivation Summary

Sysco's 'BBB' rating reflects the company's large scale, good market position, and diverse customer base with broad geographical distribution of an extensive line of food and non-food items including Sysco-branded products with an estimated 17% share of the U.S. foodservice market. Fitch expects Sysco will demonstrate consistent capital allocation priorities by investing in the business including bolt-on M&A and returning value to shareholders with leverage expected around 3.2x.

Based on Fitch's assessment of Sysco's financial flexibility, the agency assigns the higher of two short-term options (F2) for the current rating profile. Any material weakening in financial flexibility, financial structure or operating environment conditions could lead to the assignment of the lower of the two short-term rating options for the current long-term profile.

In comparison to its main competitors, U.S. Foods Holding, Corp and Performance Foods, Sysco is substantially larger with LTM annual sales of more than $70 billion. Sysco's financial profile is materially stronger than U.S. Foods or Performance Foods with higher margins, lower leverage and greater FCF generation capabilities. Sysco's margins are higher given more efficient operations, better route density and product mix.

Other 'BBB' rated peers within the consumer and restaurant space include Altria (BBB/Stable) and Darden Restaurants Inc. (BBB/Stable).

Darden's rating reflects its moderate financial leverage sustained below 3x on a Fitch adjusted basis, good FCF, diversified portfolio of casual restaurant brands, and proven ability to outperform the broader casual dining segment which has been experiencing traffic declines due to increased competition from the rapidly growing fast-casual restaurant segment.

Altria's rating reflects its position as the industry leader in the U.S. cigarette market anchored by its Marlboro franchise and leading positions in MST with strong profitability and growing cash generation that benefits from good pricing power with expectations for mid-2.0x leverage.

Key Assumptions

Fitch's Key Assumptions Within the Agency's Rating Case for the Issuer:

Fitch projects Sysco's fiscal 2023 net sales could increase by approximately 12%, approaching $77 billion reflecting inflationary pricing, further volume recovery in segments impacted by pandemic including foodservice management, international markets that were slower to recover due to omicron related restrictions and travel/leisure, and benefits from growth-related initiatives.

Sales growth could be around the low-single digits in fiscal 2024 to around $78 billion reflecting market share gains, benefits from growth related initiatives and bolt-on M&A offset by pressures from a weakening global macro-environment, reduced consumer spending in food-away-from-home and deflationary pricing for certain commodities.

Fitch projects Sysco's fiscal 2023 EBITDA could be approximately $3.7 billion, which is a 12% yoy increase. EBITDA is supported by good top-line growth as Sysco captures market share in food-away-from-home that is benefitting from numerous Sysco related growth initiatives, while passing through a vast majority of input cost inflation and on-going efficiencies and volume growth. The second half of fiscal 2023 could see a greater benefit from normalization in some of the supply chain related issues, progress from growth initiatives, improvement in labor productivity and lapping of Omicron-related effects.

However, given growing global macroeconomic pressures and uncertainty from unprecedented inflation, tightening monetary policies and evolving consumer spending patterns, lower EBITDA growth relative to Fitch's forecast remains a risk.

Fitch projects EBITDA around $3.8 billion in fiscal 2024 reflecting benefits from growth initiatives that is driving increasing independent wallet share increasing Sysco brand penetration, efficiency improvements and a moderation in inflation.

FCF could be around $500 million fiscal 2023 given good top-line and EBITDA growth, offset by investments in working capital inventory and capex of more than $700 million. FCF could be around $900 million in fiscal 2024, reflecting continued EBITDA improvement, capex of more than $700 million and a significant moderation in working capital investments.

Leverage around 3.2x in fiscal 2023 due to EBITDA growth and modestly higher debt levels with leverage remaining in the low 3x over the forecast period. This compares with 3.3x in fiscal 2022 and 5.1x in fiscal 2021.

Share repurchases are projected around $500 million in fiscal 2023 and increasing in fiscal 2024.

Annual bolt-on M&A is assumed over the forecast period.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive rating upgrade to 'BBB+' is not anticipated in the intermediate term given Sysco's current financial policy target of net leverage of 2.5x to 2.75x, which roughly equates to Fitch's leverage (lease-adjusted debt to EBITDAR) calculation of 3.0x to 3.25x. Developments that may lead to a positive rating action include:

Sustained sales growth of at least 2%-3% with improving margins that results in EBITDA growth in the low to mid-single digits and ample FCF generation characterized by FCF margins sustained around 1% that supports leverage sustained around 2.5x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Leverage sustained above 3.3x due to weaker than expected operating performance, a more aggressive financial strategy related to M&A and/or shareholder initiatives.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Strong Liquidity Position: As of the first quarter fiscal 2023, Sysco's cash balance was $438 million. This compares to elevated cash levels in response to the disrupted business operations due to the pandemic with cash balances of approximately $3.0 billion and $6.1 billion in FY 2021 and FY 2020, respectively.

Sysco's liquidity position also includes $2.8 billion of availability on its $3 billion revolving credit facility maturing 2027 with $203 million of letters of credit outstanding. As of Oct. 1, 2022, there were $97 million in commercial paper issuances outstanding under this program. On April 29 2022, Sysco replaced its previous $2 billion revolving credit facility with a $3 billion facility, which allows the company the option to increase the commitment to $4 billion.

Additionally, the new facility includes a covenant requiring Sysco to maintain a ratio of consolidated EBITDA to consolidated interest expense of 3x. During the first quarter of FY 2023, Sysco upsized the CP program to $3 billion from $2 billion.

Upcoming long-term maturities are very manageable with $500 million coming due in FY 2023 that Fitch expects will be refinanced. Sysco does not have any maturities in FY 2024. During FY 2022, Sysco repaid $450 million in maturing senior notes due during the fiscal year and refinanced $1.25 billion of notes maturing in FY 2025 that extended maturities and reduced interest costs.

Issuer Profile

Sysco is the largest global distributor of food and related products to the foodservice or food-away-from-home industry. Sysco's primary operations are located in North America and Europe with an estimated 17% share of the U.S. foodservice market.

Summary of Financial Adjustments

Fair value of debt adjusted to reflect debt amount payable on maturity, stock-based compensation, restructuring related charges, acquisition related intangible amortization expenses and other one-time items.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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