This Food IPO Looks Like Leftovers

Could the spring thaw be working its magic for the initial public offering (IPO) market? After a rough start to the year the stock market seems to have an increased appetite for IPO deals, and that bodes well for the market in general.

A litmus test on just how healthy the IPO market had become is this week’s pending IPO of US Foods, the year’s first deal to top $1 billion and one that will test the market’s penchant for larger deals. Although US Foods has a crackerjack team of underwriters supporting it, we think the combination of the company’s lackluster growth mixed with a frothy valuation make for a bad recipe.

We’d advise investors to keep this deal off their plate, even if the stock takes a hit after going to market.

In addition to more IPO deals coming to market, the variety of deals is improving. Recent successful IPOs for technology company Acacia Communications and garden supply company SiteOne Landscaping Supply indicate investors’ may be hungry for deals outside of biotech, which have been dominating the market.

Number One Player, But …

US Foods is the second largest foodservice distributor in the United States. Sysco, the number one player in the market, attempted to buy US Foods in a huge $8 billion deal in 2013. After two years of wrangling with the courts over antitrust issues, Sysco dropped its proposal in June 2015.

When the $8 billion deal fell apart last summer, US Foods largest shareholders came up with Plan B. Although the $5 billion valuation the market is assigning to the IPO is significantly less than Sysco’s deal price, the IPO gives insiders an exit plan to sell their shares in the future.

US Foods two largest shareholders, Clayton Dubilier &Rice and KKR collectively own 169 million or 77% of shares outstanding.  They are not selling any shares in this deal but will likely start to sell their shares over the course of the year via secondary offerings.

Despite the valuation of the company being much lower than Sysco’s proposed price, we think the deal smells like three-day old fish. US Foods has lost money almost every year since 2011. The exception was 2015 when Sysco’s deal termination fee pushed it into the black.

US Foods revenue has been flat for two years and before that grew revenue at a compound rate of just 3%. Compare this to competitors Sysco and Performance Food Group. Sysco grew revenue 5% last year and smaller Performance Food Group (NSDQ: PFGC) increased revenue 11%.

Gigantic interest payments devoured the little operating income available to US Foods, a trend that shows no sign of stopping due to the additional $670 million in debt taken on to fund a special dividend to insiders before the IPO.

Although both Sysco and Performance Food Group have significant debt due to a series of smaller acquisitions, interest payments eat up just 14% of Sysco’s operating income and 53% of Performance Food Group’s versus all of US Foods’.

The most generous peer valuation I see is a 33 PE on historical earnings. If I generously assume US Foods can annualize the $.08 profit it recorded in the first quarter, the stock will sell at 70 times 2016 profits, a gut wrenching valuation which leaves me feeling queasy.

P.S.: I am the chief strategist for Investing Daily’s Growth Stock Strategist and Profit Catalyst Alert. In those publications I recommend stocks, usually small company stocks, that the market has overlooked and that have the potential for great gains.  Feel free to use the Stock Talk feature beneath this article if you have any questions about my columns. 

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