Aramark (ARMK) Earnings Call Transcript & Summary

Good morning, everyone. And for those of you who don't know me, I'm Harry Martin, Bernstein's business services analyst. And I'm delighted to welcome again, John Zillmer, Aramark's CEO, to the Bernstein SDC. I thought just to kick things off, it would be good if you could just give an introduction to yourself and Aramark and then a quick outline of what you see as the key investment opportunity today in Aramark's stock.

Terrific. Thank you. Well, I'm John Zillmer. I've been the CEO for the last 3 years of the company. I spent a very significant amount to my time in the company prior to leaving in 2004 and then returned to the company in 2019. And this is an industry that has a fantastic potential, great growth opportunity, and it's one that I'm very much committed to, grew up in and love and really enjoy the hospitality sector. This company, in particular, has, I think, a terrific potential going forward. So I think for us, the story is really about growth. This total addressable market in this industry is extraordinarily large. Today, we're operating in an environment where we have 2 large competitors and a lot of small regional competitors, both domestically and internationally. And we compete very aggressively for business, but the total addressable market is billions of dollars, tens of billions of dollars, and the opportunity for us really is limitless. We have, over the last couple of years, really reenergized the growth culture, the hospitality culture of the organization and have a focused team and great leadership, really, I think, having an impact on the business for our customers and for our shareholders as well.

Great. Thanks for that. And I guess just a couple of questions at the top on where the business is in terms of current trends. There's a lot of different moving parts in play at the moment in terms of cycles, recovery, macro. When you think about the volumes in the business today, is it time to stop thinking about volume recovery from the pandemic? Or are there still a few segments that have some room to go in the second half of this year?

Yes, there are a couple of segments that still have some opportunity to continue to recover pre-COVID volumes. And the business industry sector, both domestically and internationally, still has some recovery left. And we think we'll -- that will play out over the balance of this year. The convention center business is slowly returning. The calendars are booked. Events are now being scheduled and so the convention centers are ramping up, but that's still not quite at the level that it was before. But beyond those 2, the rest of the businesses have really recovered and are at pre-COVID levels and beyond, both from a base volume perspective as well as a growth perspective.

And when I think back to last year, we were talking about very strong per capita spending in sports stadiums. Is that something that's moderated a little bit? Or is that still very high?

No, it's still very high. That's something that's very encouraging. I think the per capita spending is still running significantly above the levels previous. And I think a lot of that is just enhanced customer capabilities, enhanced both from an offering perspective as well as a payment perspective. The payment systems drove significant increases in the per capita spending as customers were had touchless opportunities. But then we've also given them a much bigger range of choice with technology in markets. For example, if you go to a Minute Maid Park in Houston or you go to Colorado Rockies Stadium, you can walk into essentially an Amazon Go type outlet and walk in, get your beer out of the cooler and walk out without ever having to touch a customer or wait in the line, or touch an employee and wait in the line. So giving that range of choice has also, I think, significantly driven the per capita spending. And we're seeing a very robust concert season over the summer. Taylor Swift is -- I think we have 35 Taylor Swift dates in our various venues, and she's producing almost $2 million a night in revenues, which -- so that's a very encouraging sign.

Okay. And then in terms of pricing, obviously, a hot topic and cost inflation. Inflation has been persisting ahead of pricing for a number of quarters. Have you had to change the way at all that you monitor inflation and set these sort of budgets, including different cost indices and the decision-making process or anything like that?

We monitor in a very detailed way inflation by market, by product, by geography and by commodity. And so we see on a very detailed basis every month, what's happening in the inflationary environment, how it's impacting each of our individual businesses, what their strategies are to recover those cost increases. And we're seeing, as I think the world is seeing, a kind of a moderation of inflation that we believe is happening currently and will begin to continue to moderate over the second half of this year. But we're seeing the index that's most relevant to the consumer -- to our marketplace is really food away from home, and we monitor it literally product by product, commodity by commodity. And that is still -- prices are still increasing, but at a lower rate. So last year, we were seeing inflation accelerate. Through the back half of this year, we're seeing it moderate, and we think that's also very encouraging.

Okay. And then on the new wins portion, can you help break down a little bit how much of the record business wins that you're seeing today are from elevated demand in the marketplace? And how much is Aramark taking more share of what's coming on offer?

I think we're getting our fair share. We are -- I think there has been an acceleration of self-op conversion over the last couple of years as organizations dealt with, first, COVID and now continuing inflationary impacts. They're making a decision to outsource more often. But that's also a trend that we see continuing. Our pipeline is very robust in both self-op and conversion -- self-op conversion opportunities as well as competitive opportunities. And again, the total addressable market is so large. We're not really concerned. We typically sell about 35% a year as self-op conversions, 35% is from our major competitors, and the balance from the regionals. And we see that trend continuing. And what's driving our record growth is really more of the focus and the discipline that we brought to the sales organization, the change in growth culture, the change in incentive systems. So we now have everything aligned and that growth engine operating at a very effective basis. I spent 2 hours with the senior leadership team this week talking about, okay, so we've gone from flat to very good. Now how do we go to great? So our expectations are to continue to develop and to make changes and to find ways to continue to grow even more rapidly than we've been able to over the last couple of years.

Okay. I'd love to hear a bit more about the changes in the product offer, which markets you think are the most attractive in terms of that growth opportunity and getting that acceleration from already a good level.

Yes. I think we believe we have a very highly customized approach to the offering that we develop for our potential clients and customers. And so we see that as an opportunity to really create for them an environment that optimizes for their consumer. And so we're not focused on a particular product or a particular marketplace. We're focused on how do we serve the needs of that particular client in the most effective way. And we do that through a high degree of customization, really getting a deep understanding, fundamental understanding of what their consumers are looking for in that particular building, whether it's in New York City or Philadelphia or Scottsdale, Arizona. And so that customization, I think, is what really creates the differential for us. And that was a change in behavior over the course of the last 3 years where we were selling in a much more prepackaged solution kind of set. Here are the offerings, take it or leave it, as opposed to this degree of -- high degree of customization. And that, I think, will drive continued success. Our win rates are back at historic levels, are above 35%, which is, I think, a function of both that focus and discipline and it reflects, I think, a really terrific result.

Sure. And then I guess the retention piece is something that people often forget on the net new side. You've seen your retention rates improve. Can you talk about some of the ways that you incentivize sales teams to manage retention in the business to make sure that they're retaining good contracts at good levels?

Yes, we really see the client contract as an annuity. And so we work very hard to protect that annuity and to treat that client and customer extraordinarily well, to negotiate in good faith, to manage the account in good faith. And then we align the organization with both retention specialists as well as new sales specialists. So we have people that are dedicated towards continuing to develop those relationships with our existing clients. So when the time does come for a rebid process, if it comes, that we have the relationship intact and developed in a way that allows us to succeed and retain. And that's been fundamental to driving the improvement in retention rates. We -- the company had dipped down below the 94% level back in, call it, 2017, 2018. We're back at the 96% level, which is, I think, a very strong performance and we continue to be focused on improving even from there. We've aligned the incentives of the entire organization on net new growth. And so net new for us is a component of new sales and client retention. So we don't want one or the other, we want both. And that's been the driver as well. So coincident, not only are we selling a much larger number of new accounts. Last year, almost 10% in terms of new accounts, but we're retaining at a much higher level as well.

And as a sort of related follow-up, that hasn't taken an increase in CapEx into contracts, refurbishment spend to drive retention?

No, that's exactly right. We're spending essentially at our historic rate for capital somewhere around 3% to 3.5%. In fact, we would invest more if we had clients that wanted it particularly in terms of developing longer-term contracts. If our client wanted to initiate some kind of a process that would -- say remodel a cafeteria, we would be happy to invest capital to make that happen in exchange for a long-term contract under the right financial terms. So we have the financial flexibility to do those things. We're not -- we're generally not asked. Most -- this industry has operated at kind of this level of capital intensity for quite some time. And we don't really see the competitive dynamic changing.

Okay. Something that's quite top of mind for people is cyclicality of the business, if we do get any sort of recession in the second half of the year. I mean, how do you feel about the resilience of Aramark today compared to in the past?

Yes. I think we're highly resilient as an organization. I think our portfolio is very strong, the range of services we offer, the businesses we operate in. The ones that are more recession-oriented like business and industry, potentially convention centers, even in a terrible recessionary environment like 2008, our total business shortfall was about 3% in that particular time period. So we're highly recession-resilient. And I think our portfolio is actually in better shape today than it was even then, given the mix of business, the range of opportunities and the range of markets that we serve in. And so we're highly resilient. We feel confident that even in a recessionary environment, we can manage through the cost changes or the environmental changes in a highly effective way.

And do any of the learnings from the pandemic, some of the changes in the structure of B&I contracts to deal with lower volumes actually potentially help in a recessionary environment?

Yes, absolutely. Right now, our business and industry business is operating at very high levels of management fee contracts. So I would say close to 90% of our accounts are management fee-based. And in a recessionary environment, as you know, the management fee provides downside risk protection. We've got no real P&L risk. You may have your profitability drop a little bit because of lower revenues, but there's no significant loss of profitability. And so that mitigates the recession impact even further. Back in 2008, it was probably closer to a 50-50 mix of contract types. So you had P&Ls in 50%, fees in 50%. So the impact would have been far greater then.

Okay. And then coming on to margins, really top of mind, I think, for a lot of the market. I guess where we're today and comparing it to the 7% to 7.5% target that you laid out at the Investor Day, how much of the gap to that level of margin today would you put down to cost inflation running ahead of pricing? How much is the dilutive impact of that new business win ramp? And any impact from sort of increased OpEx to drive growth?

Yes. I would say the vast difference in terms of our -- first of all, we believe very, very strongly that the pathway to the 7% to 7.5% is still intact, and that's our goal and objective. And we believe that based on the growth engine that we've built in the organization that we are on our way to achieving that margin potential. And there are 3 elements that really contribute to that margin growth. One is the growth of the new accounts. And as we sell new business, it typically takes about 2 years for an account to ramp to normalized profitability. So as you add $500 million 2 years ago, those accounts are really ramping to full profitability today. The $800 million we added last year will be really ramping over this year and next to total profitability. But then as we achieve kind of a steady state in terms of sales growth of $800 million a year, you've essentially lapped that phenomenon. And so you've got opening costs on the new business, but you've got the lapping of the maturity, the contract maturity in the other contracts. So that phenomenon, we think, will flatten and normalize going forward. But the real contributor to margin enhancement ultimately is not only frontline contribution coming from that new business. It's also the supply chain profitability that comes from adding that additional spend to the organization. So if I sell $800 million worth of business, I've added $400 million worth of spend to my supply chain, which produces significant profitability. And every time I add that spend, I'm earning at a higher level on my contracts with my manufacturer partners. So most contracts with the manufacturers are designed to reward growth. They'll pay you for a baseline. But then as you grow the business and you grow their spend and volume, they'll pay you at an enhanced level. So if you're buying 100 cases today, they'll pay you at X. If it's 200, they'll pay you at Y, and 300, they'll pay you at Z. And so it's adding that spend over an extended period of time creates that additional leverage. So when you think about the engine of growth, the supply chain profit improvement opportunity and the leverage that exists in our organization with respect to SG&A and overhead, the pathway to that margin expansion is very clear, and the math is very clear. It works. It's what fundamentally we want to do. We're not trying to improve pricing to improve margins. We're trying to sell new business, add supply chain spend, restrict the overhead. And that's the engine that produces long-term margin growth without impacting an individual consumer in an unfortunate way. So we don't see price as a lever for margin. We see price as a lever for cost recovery and these other elements are what become additive to margin over time.

Long-term margin was my next question. I think you've probably been one of the most positive on the ability of the catering business to generate that ongoing margin expansion over time. Obviously, labor going into contract is something that generally doesn't change too much, but generating that leverage on food cost has historically been something that the business has been able to do. I mean if we look at the business in 10 years' time, is that the avenue that you would have generated the most operating leverage on?

Yes, I think so. If you think in a normalized environment as we're adding new accounts, the new accounts should produce a frontline contribution margin of, call it, in a range of 5.5%. And then you add on to that the supply chain leverage and the additional contribution from those elements and then you subtract the SG&A increase, and so the combination of those 3 things really drive that enhancement. And it really is maybe an oversimplification to say growth drives everything, but it really does. It's what makes us successful in -- and frankly, it's what gets people up in the morning. They're excited to sell new accounts. They're excited to sell new opportunities like Merlin last year, that $180 million win that was new for the industry and new for us, and that's what gets us excited. And it creates -- those kinds of chunky opportunities create real leverage for us going forward.

And as a related question, can you give an update on where we are with the GPO with Avendra?

Yes, absolutely. We continue to work on building the GPO. We've made a number of small tuck-in acquisitions, both domestically and internationally, to add capability and components of spend. Those come at a very attractive price. And so we'll continue to build the spend and leverage there. We continue to expand the relationships we have with Marriott and our other GPO partners. We still have an opportunity to expand that GPO into the European marketplace where they want us to go ahead and become their provider. So there is some natural growth opportunity built into the GPO today, and we're continuing to work at ways to expand the different markets that we serve, both from a retail restaurant perspective as well as the hospitality industry, the hotel industry. But if you go down the client list of Avendra today, you'll see it's populated with 4 Seasons, with Marriott, with very high-quality names, people that are really dedicated to customer service and doing the right thing. And I'm very proud of what they've been able to achieve and build. Keep in mind that we bought a vendor right before the impact of COVID, so it was delayed a bit. But I'm excited about the progress they've made, and we're earning -- we're having a very good year on the supply chain side.

Great. And you mentioned Europe, so I think it's a good segue into the international business. I think it's a business for Aramark that's been a bit of a shining light for many years, which is probably not fully appreciated. Would you say it's fair to say that you benefit from the fact that you're focused tightly on a few countries rather than spread too widely?

Yes, absolutely. We believe we're positioned in the markets that, first of all, can deliver value for us, where we have strength to compete, where we've got capabilities and organizational talent and management to compete aggressively. And we've done a few tuck-in acquisitions in the U.K. this -- over the course of the last year. The most recent of which was a company called Graysons, which is adding catering capability to the organization in Central London, and we were just -- I can't really talk about that. There's interesting news to come about a new win that I think will be well received that was impacted by that acquisition. And so there's -- we're excited about the countries we operate in. And we have great growth in Chile in Latin America. We have terrific growth in China. Even given the difficult environment that we operate in today from a political perspective, we've got a great team there. But we're focused on those countries where we can make a difference. And I've often heard executives from other companies say that they envy our portfolio positioning in terms of where we are because we didn't go on a planting flag mission. We went on building capability in those countries where we could make a difference.

And so when I think about the growth of the international business in the next 5 years, it's unlikely we'd see more countries, more services, more segments within the countries you're already in?

Yes. That's absolutely right. We'll compete aggressively in the markets we're currently in and continue to grow them out. We'll make small tuck-in acquisitions in markets to build strength. We bought Sodexo's business, for example, in the Czech Republic. They were under -- they were subscale. We were the largest provider there. So we've made little tuck-ins to go ahead and build strength and we'll continue to do so. But I think we'll be focused on the same countries.

Sure. And then some of the peer set in Europe have suggested a bit of an attitude change towards outsourcing in a positive way in the last year or 2. Do you share that optimism? Or do you actually see the strong growth that you're already experiencing is just carrying on?

Well, I see our strong growth carrying on. I do see continued accelerated trend towards outsourcing, particularly in areas that were typically non-core. And we continue to see that trend, both domestically and internationally. Some of the businesses, for instance, Merlin was really kind of a nontraditional segment for the market, and we'll continue to pursue those kinds of opportunities. But we're seeing in the core businesses, like the U.S., significant outsourcing potential in facilities management, large customers like Boeing and others where they have taken their FM responsibilities and essentially said, they're yours, Aramark, so let's work this out over the next couple of years. So we have a wide range of those kinds of conversion opportunities as well.

Okay. And then when we think about the margin of the international business, historically, it's been a bit lower than the U.S. How much of that is just driven by the difference in scale and can close over time as the business grows? And how much is any sort of structural differences between the 2 markets?