Friday, March 27, 2009

Harvest in the Media

We were a resource for this article in the April 2009 issue of Main Line Today dealing with the current market environment. (You will find us quoted starting on page three.) We hope it provides you food for thought.

Saturday, March 21, 2009


Sysco (SYY) is a company we really like now, and for the long run. We find the stock very compelling at its current price ($22). It is the dominant food distributor to the restaurant industry with sales over $37 Billion. It also sells to customers in the healthcare, educational and lodging industries.

Sysco also has a very large private label business (with over $12 Billion in sales) that makes it one of the largest food companies. In tough economic times, restaurants may find that shifting to the Sysco brand makes a great deal of economic sense.

Sysco’s size gives it a cost advantage over its competitors that can be used to benefit its customers and its shareholders. The company has been embarking on a huge redistribution plan that should allow it to lower costs, improve productivity and reduce inventory. Sysco is also focused on doing more centralized purchasing (in the past it let its individual operating companies purchase items separately). And Sysco is focused on making its transportation system even more efficient. Sysco has the largest private fleet of trucks in North America. So far this fiscal year, it has been able to reduce its miles driven by 10 million. Given the cost of fuel, that translates into real savings. These initiatives will lead to a significant improvement in margins at Sysco.

Of course, during tough economic times, people may eat out less and restaurants will close at a more rapid pace. These are certainly factors that could hurt sales. But we think it could benefit Sysco, as restaurant owners consolidate their suppliers. Sysco also has a Business Review program, where it works closely with its customers to help them operate more effectively. This program has led to Sysco becoming a more valued supplier and increasing its sales.

While the company has about $2B in debt (compared to $300 million in cash), they issued $500m in new notes this month, so liquidity is not a concern. The company indicated that it has no immediate needs for the funds, but was taking advantage of attractive rates in the marketplace. Sysco carries an AA- rating from S&P. Only $7.5Million of Sysco’s debt is due in the next 12 months.

The company is committed to returning money to its shareholders. Sysco is a Dividend Aristocrat, meaning it has increased its dividend annually for at least 25 years. At the end of last year, it raised its dividend by 9% and the yield is now 4.4%. The dividend payout ratio is 53%. Sysco has also repurchased at least $500 million in stock in each of the last 5 years and has reduced its shares outstanding by over 50 million shares during that period.

Bottom line, Sysco is expected to earn around $1.80 in FY2009 ending in June. Assuming they earn a similar amount the following year, Sysco is trading at just over 12x forward earnings. This is a pretty reasonable price to pay for such a dominant company. The valuation coupled with a 4.4% dividend yield makes this a very interesting stock.

(Disclosure: Harvest Financial Partners owns Sysco in its client portfolios. The author owns Sysco in his personal portfolio. Positions may change at any time.)

Friday, March 20, 2009

Procter & Gamble

The Procter & Gamble Company (P&G) provides branded consumer products worldwide. The company operates in three global business units: Beauty, Health and Well-Being, and Household Care. P&G was founded in 1837 and is a Dividend Aristocrat meaning it has raised its dividend for at least 25 years.

At a share price of $45, P&G has a market cap of about $132 billion. The stock currently pays a quarterly dividend of $0.40/share, yielding over 3.5%. Analysts estimate that P&G will earn $4.25 in FY09 and $4.11 in FY10. Using the FY10 estimates, P&G’s forward PE ratio is 11 and its dividend payout ratio under 40%.

P&G generates a tremendous amount of free cash flow (cash flow after capital expenditures). In FY2008 (ending 6/08) the company had free cash of $12.2B in 2008 and that was up from $8.7B in FY2006. We expect free cash flow to be over $13B this fiscal year, so P&G is selling for a little more than 10x free cash.

At 12/31/2008 P&G had total debt of $41.7B. P&G is rated AA- by S&P and Aa3 by Moody’s. (One bond issue, the 4.85% notes due 12/15/2015, trades at about 1% over a comparable Treasury. By way of comparison, GE Capital’s nearest bond issue trades at about 4.6% over a comparable Treasury and Medtronic's nearest bond is trading at 1.8% over Treasuries.) P&G has a defined benefit pension plan and other post retirement benefits that were underfunded by $3 billion as of 6/30/08.

Management is well-regarded, deservedly so, in our opinion. The company’s portfolio is full of great consumer brands like Pampers, Tide, Crest and Gillette and is in many defensive product areas (you have to buy laundry detergent). P&G is also geographically diverse with significant sales in both developed and emerging markets. We believe that P&G is well positioned to manage through a difficult 2009 business environment. Even assuming that business is tougher than currently anticipated, we view P&G stock acquired in the mid $40’s as very attractive.

(Disclosure: Harvest Financial Partners owns Procter & Gamble in its client portfolios. The author owns Procter & Gamble in his personal account. Positions may change at any time.)

Thursday, March 12, 2009

Client Letter

Below is a copy of a letter we sent our clients earlier this week:

We debated calling this note a Downdate what with the S&P 500 down over 53% from its high, residential real estate down over 25% from its peak, the unemployment rate over 8%, questions about bank solvency persisting and lingering problems in the credit markets. It is really tough out there. So what do we do now?

We could move out of stocks and into cash. When the market is declining daily, cash allows us to sleep better. While that sounds appealing, we don’t think it is the right course. If the stock market turns around soon, those holding only cash will miss out on what could be some pretty attractive gains. Their only return will be the low interest rate being paid by money market funds or short term bonds or CDs.

With funds not needed for several years we plan to stick with stocks. Why? Because you run the risk of missing some attractive gains when stocks do turn up; and they will turn up. We cannot tell you when that will happen or how much further stocks may decline before they turn up. Our instincts do tell us we are near some kind of bottom. The pessimism and negativity coming from writers, television personalities and virtually anyone we talk to is at extreme levels. And valuations appear attractive, with many stocks selling at low multiples on earnings and cash flow, while offering nice dividend yields. This is true even for companies that are not impacted by the disruption in the credit markets like Sysco, Paychex, Microsoft, Nike, Corning, Johnson & Johnson and Stryker with little or no debt. Of course, there is risk, but the potential returns can be quite appealing.

The other question we asked ourselves is what did we learn? Looking back over the past year, we significantly underestimated the degree of disruption in the credit markets and its impact on financial institutions. We also were too slow in seeing the impact the credit crisis would have on the rest of the economy. We are disappointed in ourselves and are confident that we can do better. For example, we have sharpened our focus on the types of companies that we purchase, weeding out any that have more than minimal balance sheet risk.

We are sure that during this period you, your family, friends and neighbors have felt the impact of the weak economy in some way. It is a very disconcerting time. But we are confident that better days are ahead. Patience has become an overused term lately, but it is still valid. Things will improve.

If you would like to talk about your investments or our thoughts on what is taking place in the markets, please give us a call.

(Disclosure: Harvest Financial Partners owns Sysco, Paychex, Microsoft, Nike, Corning, Johnson & Johnson and Stryker in its client portfolios. The authors own Sysco, Paychex, Microsoft, Nike, Corning, Johnson & Johnson and Stryker in their personal portfolio. Positions may change at any time.)

Tuesday, March 3, 2009


Paychex (PAYX) provides payroll, and related human resource and employee benefits outsourcing for small- to medium-sized businesses in the United States. As of May 31, 2008, the company served approximately 572,000 clients in the United States. Paychex was founded in 1971 and is headquartered in Rochester, New York.

Payroll is probably the oldest outsourced function. There are several good reasons for this: all the different withholdings make it complicated, penalties for making mistakes are severe, the cost of outsourcing is low (dare I say cheap) and payroll is not close to a core function for most businesses. So Paychex’s core business is well established and doesn’t seem to be at any risk of being supplanted by either new technology or tax simplification. The company has used payroll as an entry point to offer a variety of additional services from 401(k) plans to insurance to HR functions. So the company has two ways to grow – find new customers and sell additional services to existing customers.

At a price of $21/share, Paychex trades at 14x expected earnings and yields over 5.9%. The company has no debt. The business is not capital intensive. If Paychex generates $600 million of free cash flow this fiscal year (less than FY08) it has a free cash flow yield of 8%, most of which investors receive through dividends.

Paychex is also an interesting play on short-term interest rates. The company collects money from clients every payroll period but holds cash for payroll taxes until the taxes are due. Rising short-term interest rates benefit Paychex as it earns more on this float. Float was over $3.5 billion at 11/30/08. So a 1% increase in short term interest rates increases earnings and free cash flow by approximately 3.5%.

We think Paychex represents an attractive business offered at an attractive price.

(Disclosure: Harvest Financial Partners owns Paychex in its client portfolios. The author owns Paychex in his personal portfolio. Positions may change at any time.)