Moody S Downgrades Sysco Debt

Texas-Based Company

Sysco is an institutional food provider, selling to restaurants, hospitals, hotels and schools. According to their latest annual report, they earned revenues of $44 billion and net income of $992 million. The company has been involved in merger and acquisition activity of late, including a purchase of Brakes Group, a European competitor, for $3.1 billion. This ended up putting Sysco in the news last month, when it was downgraded by Moody's. The credit agency downgraded Sysco debt from A3 to A2, over concerns that the company was going to engage in further M&A activity, which would see the company increase its debt to levels that are more challenging (No author, 2016).

One of the reasons Moody's is so concerned is not just because of the Brakes purchase, but because Sysco attempted to buy U.S. Foods last year, only to have the deal rejected by regulators. Sysco appears to see mergers and acquisitions as the only way forward for its business, but the credit agency sees risk in increasing its leverage to facilitate these transactions. The concern is that the management team is too fixated on this type of growth, and that might lead the company to make a bad decision going forward.

The Moody's downgrade is relevant for a couple of reasons. First, it means that the cost of capital for Sysco is going to increase. The downgrade will mean that investors require a higher risk premium for holding Moody's debt. This does not affect the company's existing debt (though this will have a higher yield in the secondary market), but it does mean that if Moody's wants to issue further debt, it will have to pay a higher rate. Should Moody's need to issue debt to help accommodate its M&A ambitions, the downgrade will cost the company potentially millions of dollars.

The second ramification of the downgrade is what it means for market sentiment with respect to the company's strategy. While the people running Sysco appear to believe that mergers/acquisitions are a key pathway to growth, the market does not seem to share the same enthusiasm. The company already had one merger rejected by regulators, before turning to Europe. But the market's impression of this strategy is that it increases the risk associated with the company. Sysco will likely pursue less desirable acquisitions, since this is the pathway that leadership is on. Moreover, they might go into further debt to do it. Either way, Moody's does not feel that this is the best strategy because it increases the company's risk.

Equity investors, it should be noted, take a different view. The company's stock has been on a long-run increase, and that trajectory has not changed with either the failed acquisition nor with the downgrade. But it does highlight the role that outsiders play in the management of a company. There are a number of external stakeholders that managers must take into account when making decisions. In this case, the major external stakeholder is the debt rating agency, which is responsible for the credit rating, and has a track record of being trustworthy to bond investors. Bond investors are wary to protect their investments, and demand a higher risk premium when the company is engaged in riskier activities. Shareholders might be more willing to see Sysco adopt an aggressive growth strategy, but bondholders clearly are not.