Sobeys to sell unit to giant Sysco

Industry analysts said the sale of SERCA did not come as a surprise because Sobeys has been trying to unload the orphan division since it was picked up as part of the acquisition of the IGA supermarket chain three years ago.

The Globe and Mail
December 6, 2001

Sobeys to sell unit to giant Sysco
Firms also strike strategic alliance
Oliver Bertin

Investors seemed curiously unenthused but Sobeys did the right thing when it finally announced it was selling SERCA, its food service business.

At 20 per cent of revenue but only 14 per cent of EBITDA (earnings before interest, taxes, depreciation and amortization), it's clear that the unit – which supplies restaurants — was a bruised apple, dragging down profitability. In an industry where thin margins are the norm at the best of times, even slight changes can make a big difference.

Sobeys' relatively low margins (3.2 per cent trailing EBITDA compared with 6.4 per cent for Loblaw) probably go a long way to explaining its relatively low stock multiple (about 14 times earnings compared with 25 times). Selling SERCA to Sysco of Houston should help narrow that gap and free Sobeys' management to attend to other pressing matters.

It's too bad the company didn't sell the unit earlier. Consolidation fever swept over the food service industry between early last year and early this year as Holland's ambitious Royal Ahold went on a buying spree. Companies were sold for lofty premiums that averaged 13 times trailing EBITDA.

SERCA, a creaky, less profitable operation (with EBITDA margins of 2.7 per cent compared with an average of 4.9 per cent for recently acquired firms) would probably have fetched a value at the lower end of the range (11 to 16 times EBITDA) or maybe even below it. But the price would likely have been more than the $440-million Sysco is offering. That price, in fact, doesn't seem like much of a premium at all, at 7.5 times EBITDA (Sysco is also assuming certain liabilities as well). Perhaps that explains the cool reaction from the market.

At any rate, Sobeys will use the proceeds wisely. Two-thirds will be applied to reducing debt, which is too high at $660-million, which will improve the balance sheet and therefore the firm's credit (Dominion Bond Rating Service seems ready to upgrade the company). The rest will be used to try to improve the grocery operations, which are in a tight battle across the country.

All in all, this is a good deal that should improve the company's stock price. The next step will be a little more challenging.

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