The key takeaway from the latest Investor Day event for Aramark (ARMK), the leading provider of foodservice, facilities and uniforms, was the unveiling of its ambitious new goals for fiscal year 2025, suggesting significant growth and margin acceleration (compared to historical numbers) ahead. Recent changes in leadership, organizational focus and culture should also help ARMK extend its recent momentum of net new business growth into the coming years, bolstering the feasibility of its longer-term growth goals. Assuming ARMK shares hold current c. 16x the P/E valuation multiple, then the midpoint of guidance (discounted to cost of equity) would be a significant upside from current levels, which would keep me bullish.
Laying the groundwork for a post-COVID-19 growth paradigm
Encouragingly, ARMK’s message at the event focused primarily on accelerating revenue growth, having rebuilt its leadership in every segment of the organization. Within this goal, the updated FY2025 targets are: $20 billion in revenue (including 4-5% net new business growth, 1-2% price/volume growth existing business and the recovery of COVID-19 revenues), as well as adjusted operating income of $1.6-1.9 billion (implying a solid margin range of 7-7.5% compared to FY2022 forecast of 5% to 5.5%). Although the targets seem ambitious at first glance, I also see some conservatism here as the price/volume component assumes that inflation returns to normalized levels over time – if inflation were instead to remain at current levels, it there would therefore be an advantage to these figures because the prices would be crossed. There could also be a benefit of the remaining $1.6-1.9 billion in recovering volumes impacted by COVID-19, with the majority not expected to be realized until fiscal year 2023/24. And given that hybrid working trends are only expected to impact white-collar workers (equivalent to 4-5% of overall activity), I see limited ongoing impact from any shifts to hybrid working within of the B&I segment in the future.
Newly installed uniform division chief impresses but no fallout yet
Judging by the Investor Day presentation, the hiring of former TMX COO Kim Scott as president and CEO of the Uniform business appears to be a wise decision. She particularly focused on the deployment of the ABS (“Automated Billing System”), which is now more than 70% complete, to evolve the Aramark field team towards customer service and sales. crossed. The segment is also looking to increase its newly hired headcount, continuing the wave of hiring during the pandemic (+35% increase in sales force headcount) to reach full productivity. Beyond that, key levers to improve performance within the Uniforms business include improving route density and merchandise management, both of which remain issues for the segment. With the uniforms addressable market opportunity also pegged at $40 billion, with plenty of additional stock capture opportunities available given c. 72% of this is owned by smaller suppliers, the avenue for organic growth is vast.
It should also be noted that management reiterates the Board’s openness to considering how to maximize value through potential strategic alternatives for the Uniforms business. In the short term, however, the strategy remains to improve the business internally before initiating any potential transaction. I view this as a prudent step – given peers Cintas (CTAS) and UniFirst (UNF) are trading in a wide EV/EBITDA range in line with their organic growth and margins, improving fundamentals should precede any process spin-off for the Uniform business. As Aramark Uniform is currently showing slower organic revenue growth and lower margins than Cintas, I agree that the optimal path to maximize value is likely to provide the new CEO with the resources to implement a large-scale transformation. .
Balance sheet flexibility underpins capital allocation priorities
ARMK’s capital allocation priorities remain unchanged – the focus is on organic growth investments followed by opportunistic add-ons, as well as debt repayment and quarterly dividends. However, as the company deleverages, management has expressed openness to other potential cash yield opportunities – note that the current net leverage target is 3.0 to 3.5x by FY 2025, well below the 8.2x at the end of 2021. I consider the target also within reach, given that the company has no debt maturities before 2025, while also benefiting from flexible covenants and an attractive balance between fixed and variable rates. Also noteworthy are the multiple tranches of notes redeemable in 2022, including the $1.5 billion 6.375% COVID-19 Notes due 2025, all of which present attractive near-term deleveraging opportunities.
Looking ahead, ARMK has also guided towards $2.5 billion in FCF generation over the next four years, targeting conversion rates of 50-55% FCF as a % of adjusted operating profit – significantly more. higher than historical c. 45% level despite cash flow seasonality expected to return in the coming fiscal year. Coupled with the flexibility of the ARMK business model, a return to predictable cash flow in a normalized post-COVID-19 environment leaves the company well positioned to manage its debt profile heading into fiscal 2022 The balance sheet position also opens an M&A option, allowing ARMK to remain opportunistic, particularly in international trade, as it seeks to expand its services in key regions.
Overall, this is a positive development for Aramark investors, with management’s tone confident in achieving its mid-term organic growth target of 5-7% through gains net new business, likely to support margin expansion also through fiscal 2025. With fiscal 2021 results signaling that recent leadership changes and strategic initiatives are already bearing fruit, I believe management’s targets reflect an upside scenario supporting the positive risk-reward ratio. An additional upside option could also come from potential strategic alternatives for the uniform segment, as the newly installed President and CEO of Aramark Uniform Services drives a large-scale transformation in anticipation of a fallout on any line. Compared to the currently discounted 16x P/E, ARMK shares offer attractive value.