Aramark (ARMK) Earnings Call Transcript & Summary

Good morning, everybody. I'm Ian Zaffino. I'm the equity research analyst over here at Oppenheimer. Thanks for joining the conference today. With me today is Aramark. And -- Outperform rating, $50 price target on the stock. Joining me today from the company is John Zillmer, the company's CEO; also Tom Ondrof, the company's CFO. We're going to do a fireside chat today. I'm going to ask some questions. And then we'll turn it over to the audience. Anyone who has a question, can you please put it in the chat or you could directly e-mail me at [email protected] and I'd be more than happy to ask that question as well and have all your questions answered. So with that John, Tom, thank you for joining us.

Maybe I'll just kick it off with a question. You guys have been seeing some very good growth recently maybe walk us through what's driving that and kind of how you're seeing the environment right now and what's working? And then maybe what -- do you think you need to work on that could potentially work as well and help you grow even faster than you're growing right now.

Certainly. I think both Tom and I can take a shot at that. First of all, we're enjoying significant net new business growth in the last 2 years. Have been -- have seen significant improvement in our new account sales activity as well as our client retention rates. And so our net growth numbers have been dramatically improved over the run rates prior to Tom and I rejoining the company, and that's been a significant contributor. Those roll-on effects of the new accounts sold 2 years ago and then last year, having a significant impact on the business. And we're also seeing continued business recovery in certain lines of business that were more COVID affected. So we're seeing recovery in -- continued recovery in B&I. We're seeing continued recovery in the conference center and convention center business with, we believe, more improvement yet to come. But -- then we're also seeing growth as a result of improved pricing to recover inflationary cost pressures. And overall, we're extraordinarily pleased with the growth trajectory of the company. We've reinvigorated the growth model inside the organization, made significant investments in sales infrastructure and sales leadership. And we're seeing the fruits of those investments here over the last couple of years. Tom, anything you want to add?

Yes. I think the only thing I'd add just to the macro environment is the push to outsourcing. I mean it really sort of hit a peak post-COVID the new complexity that was introduced into the services we provide, health, hygiene, sanitation, packaging, all that sort of stuff as well as some of the technology that had to be introduced to really take some of the human contact out for a while. That push to outsourcing continues with the complexity introduced from inflation and supply chain disruption. So I think all those things have been tailwinds to the outsourcing push. But just a reminder to -- because I get asked a lot about how long that will continue. The market is just so big. It was pre-COVID. The opportunity is so large that long may the first-time outsourcing trend continue at the rate it has been, but we feel very confident in the marketplace itself that we can sustain our mid-single-digit target growth rate even if that levels out to pre-COVID -- sort of normal outsourcing pace.

Okay. Great. That's very helpful. So if we look at like a higher level, how is demand tracking in the U.S. business? Maybe what verticals are standing out. And how are they doing versus kind of your internal expectations?

Yes. I would say demand is tracking very well across the enterprise. We're seeing good recovery across all the lines of business. Really, the only business that is still somewhat lagging full recovery of COVID, pre-COVID revenues would be business dining, but even that is in the mid-90s, and we expect to continue to evolve over a period of time. So demand, I think, very strong across all the verticals we operate, Sports & Entertainment, travel and tourism, national parks, seeing significant demand growth this year, especially as some of the major parks are seeing increased visitorship. And of course, we expect a busy concert season this year. So overall demand tracking very well across the enterprise, both domestically and internationally. We're seeing a little bit of dislocation in the European marketplace. In some countries, we're -- primarily Spain, where the business impacts are -- have been a little bit more significant, but Germany doing extraordinarily well. The U.K. doing extraordinarily well. So all-in business demand tracking very well. Tom, anything to add?

Yes. I mean, overall, I mean, revenues are about 115% of pre-COVID. So obviously, to and -- through and beyond where we were before. That certainly has been helped a bit by inflation and the need for pricing. But as John said, the overall company recovery is up into the mid-90s. B&I itself is probably low 80s, but the weighted average of everything else being so strong is -- got us well over pre-COVID revenue levels. And we see that continuing on the back of pricing and as we just talked about the strength in outsourcing in that growth.

Okay. So I know you talked about B&I. And I guess we're hearing mixed things about B&I right now. New York City just hit their -- just surpassed 50% office occupancy for the first time, I think since pre-COVID. So super positive data point there. But then I guess you're seeing in like San Francisco, you're seeing all these articles right now about a lot of that downtown office space being converted to other purposes. So kind of in all these mixed messages we're seeing and hearing, what do you think the potential is? Or do we get back to pre-COVID levels in B&I? Or is it maybe permanently impaired?

Well, I think certainly, the business will get back to pre-COVID levels and well beyond because we're going to grow the business beyond those accounts that we served pre-COVID. And so -- and the individual location may be slightly smaller in the future than it was historically, but the business will continue to grow and will continue to prosper. That -- we're seeing improved participation rates in the locations that we do operate. So when people are in the office, they're utilizing the facilities more aggressively. And companies are beginning to really reemphasize the return-to-work strategy. So I think you'll continue to see that evolving over a period of time, whether every single individual location never gets back to 100%, it really doesn't matter to us. The business is profitable, it's growing, we're selling new accounts, we're adding new business and ultimately if a single location comes back to 90%, we're fine with that. We'll serve more customers, we'll price, we'll get new accounts and the business will be just fine.

Right, right. Okay. Good. So the base would maybe be 90% and then you layer on top of that new wins, better pricing and then you're well north of what you did before.

Yes, absolutely.

And then can we just touch upon -- we're talking about pricing here. So maybe talk a little bit about the pricing environment now, both what you're seeing on the cost side from inflation, your ability to kind of pass that through in the form of pricing. And then what happens as the environment starts normalizing? So as food costs come down, and what is your pricing do in that environment? Or what do your margins do?

Tom, do you want to take the first shot at this?

Yes. We'd like to see it level out. I'm not sure 1%, 2% pricing is or inflation is great. Certainly, 8%, 9%, 10% is not great. So sort of 3% to 4% is more of a sweet spot. Certainly, having the supply chain and the distribution networks back to normal is equally as important so that we can get back to right products, right suppliers. Pricing won't -- there's not a rollback. There's not a giveback. We're not a discounting environment. So we feel very good about that as inflation eventually eases, it will produce a tailwind for us, and we just got to stay with it. catch up for lost time sort of speak over these past 18 months or so as we move forward and inflation does start to ease.

Okay. And so how do you see -- or if you were to look at your crystal ball, when can you start getting back to the margins that you saw previously?

Yes. I mean, there's a whole combination of things in there. We had a business that John walked into, that I walked into that was underinvested in and not to make any excuses or apologies, but certainly reinvigorating the growth story took time and money and focus that was done since '19. So benchmarking against '19. That needs to be taken into consideration. So getting back to those historical margin, pre-COVID margins, we're well on pace for it. We still feel very confident about it. Inflation has been obviously a headwind to recovering to those pre-COVID margins. And the investments that we've had to make, primarily in growth resources. But the trajectory is really strong. I mean we improved from a low of 2.5% a couple of years ago. Increased 250 basis points in '22. We'll have another significant increase this year, and we expect that to continue to move forward.

Yes, that it's absolutely right. We built this growth engine, if you will, in order to generate, enhance margins over time as the company grows and we add additional supply chain spend, we improved margin there. And as we continue to leverage the overhead of the organization as we can continue to add significant new business to the enterprise without significantly adding to the SG&A of the company. So the model works. It's -- you continue to add that 5% mid-single-digit growth rate and the supply chain leverage and the SG&A leverage and the margins accrete very nicely, as Tom indicated. And we're committed to the margin targets that we established at our Investor Day a couple of years ago, and we're well on the path to achieving those objectives that we laid out.

Perfect. Perfect. And I know we touched upon the international side a little bit, but can you give us maybe a broader idea because you're bigger than just U.K., Germany and Spain. So maybe give us a broader view of what's going on, how would you characterize demand? What geographies are performing well? What's still in recovery mode? And then maybe walk us through the margins that you're seeing there compared to the U.S.

Sure. I'll take a start at that. First of all, we're seeing demand around the globe, in all the countries that we operate in predominantly doing very, very well. Latin America, very strong; Chile, very strong; China, doing well. So all in all, our international business is performing very well and according to expectations. We're consistently growing that business. We see improving net new business results, improving retention results. So overall, international, we're very pleased with. And we're in the countries where we want to operate. We feel like we're in the geographies where we have the best opportunity to win, where we've got the right portfolio. And we continue to invest, making small incremental acquisitions in certain geographies to go ahead and enhance the structural scale of the business that we operate. And overall margins, unit level margins in international are just as strong as our domestic margins. The really -- the gap between our net margins is really driven by scale. And as we continue to build those businesses, we'll -- with those margins internationally. Again, we can add significant new business without adding additional SG&A. And so we feel like we've got a strong path to improving margins in international as well. Tom?

No, I agree with everything you said. Not a whole lot to add there. We feel very good about the countries we're in. We're not particularly interested in planting any new flags at this point. We continue to add the density and build the scale, as John just said, in the countries we're in.

Okay. And since you mentioned China, any impact during the COVID increase count or case count? Have you noticed anything there?

There was a little blip -- sorry, John.

No, go ahead, Tom.

Yes, a little blip in there. I think we mentioned it in the last earnings call in January, there was a -- they had some shutdowns, but nothing noticeable or particularly material to the total company.

And nothing recently either?

No.

No.

Okay. Perfect. And I guess the other kind of macro topic of the day is recession. Who knows if we're going in one, if we're not going in one. But it's always kind of looming out there. So maybe walk us through, are you seeing any signs of that? Have you seen like any type of softness whatsoever related to the economy. Or maybe heading into a recession and then also maybe talk about how the business does in a recession.

Yes, go ahead.

I'll take a stab at that. First of all, I would say from a business unit perspective, we are not seeing indications of recession yet. Our business is very recession resilient even in 2008 during the banking crisis. Our revenues were very strong. We're only off a few percentage points. Earnings were very close. So the business itself is very recession-resilient. That's owing to the portfolio mix. We have strong businesses that kind of mitigate the impacts of inflation and in particular, really the only business that's most sensitive to inflation would be the business and industry sector. And today, because of the contract structure in the industry being predominantly management fee, we are somewhat insulated from the impacts of recession even in that business segment. So again, not seeing indications of it yet. We're seeing strong demand in some of our key businesses, particularly those where consumers are engaging in experiential behaviors like Sports & Entertainment, parks and the like. So I would say it's anybody's guess. We don't know any more than anybody else does, but we're not seeing anything really impacting the numbers.

Okay. Okay. And I know, John, you mentioned this just earlier in one of your original kind of comments was new wins, et cetera. So maybe let's just spend a little time on that. What's the main driver here of the winning the new business, self-op versus regional or major competitors, you taking share? And then maybe also talk about retention, what you're doing there. and how that's really been tracking over the past 7 years during your tenure?

Sure, Tom, do you want to take the first stab at this?

Yes. Ian, I think the cultural shift was not that difficult. I mean people like to grow, people like to win. And certainly, our marketplace, as I mentioned earlier, is so large that to not grow is really a choice. So when John came back in, and he and I were talking, the idea of growing was not one that it was going to -- we thought was going to be a massively heavy lift other than getting the resources back into the business and making sure we had the right people. So those things were done early on while we were dealing with COVID as well. The sales force had been cut 40% prior to John arriving, all part of the margin march and growth can be messy too. I mean there's a drag on margins early on in most contracts. Particularly the bigger ones. So not growing is sort of a margin play in the short run, but not in the long run. So adding those resources, taking some of the bureaucracy out of the approval process, we're really getting more creative with how we would go to market understanding that every one of our lines of business can grow. That was another fallacy, I think that some were slower growers or no growers, but all of them have opportunity. So it's really get the everybody-sells mentality back into the business. So that's really what's happened. And then we call it the tailwind of outsourcing. And certainly, that's helped. And now we have a more fundamental base as that levels out to be able to take our growth forward. So we feel we're well positioned. We look at the pipeline going into fiscal '24, and it looks strong. So we're pleased with where we are and the resources that we have in place now.

Yes. And I would just add, this business functions very well when you have people that are dedicated to lines of business, that have deep understandings -- that have a deep understanding of the business they operate, the business they sell and have the opportunity to develop relationships with those potential buyers. And that is an extraordinarily important key. So having those dedicated resources that we invested in a couple of years ago, really maturing in their businesses and maturing in their marketplaces have -- had a dramatic impact on those sales results and will continue to have an impact going forward. We built this growth engine to continue to grow into perpetuity, to have a consistent growth model in place which is the way this industry has functioned best for decades. And so remaining committed to it, keeping people devoted to those businesses is key to making sure that we continue that success, and that's what we're doing.

Okay. And maybe, Tom, can you walk us through or remind us what the dilution is that you're facing from all these new business wins? When does it reverse and become a tailwind?

Yes. I mean we haven't come out with specifics because it is an account-by-account sort of phenomenon. But certainly, generally, the smaller the account, the quicker it can ramp usually within 3 to 6 months, it can be hitting a pretty efficient unit-level margin. The bigger ones, Merlin being the extreme example can take a few years before you're really comfortable with the operating flow, consumer flow within the units and really be able to menu engineer and labor engineer effectively to where you get to a peak margin. So it's anywhere from a few months to a few years depending on size.

Okay. And now if we were to touch upon Uniforms here, how has that business been doing post-COVID versus your expectations? And then maybe just give a holistic discussion about what you're seeing as far as like long-term tailwinds in that business?

Sure. The business is -- the business responded and recovered from COVID more rapidly than the Food business and the margins came back to much more normalized levels pretty rapidly. And we're -- during that time period, we continued to invest in the infrastructure, the rollout of ABS, the investments that we made in organization in order to go ahead and facilitate what we believe would ultimately be the right strategic decision to go ahead and spin that business into an independent company. So I would say from a margin perspective, they've made significant progress. They continue to show progress. On the growth side, there's been improvements in net new business and in client retention. Last year, they did implement a fuel recovery fee that was in place for about 6 months at the height of the higher fuel costs. And then that rolled off in the first quarter of this year. So they're comping against a higher number from a growth perspective due to that fuel recovery fee that was in the numbers last year. So I think they're on the right trajectory. The business is really working very hard to build its logistical strength, it's operating strength and to be an independent company here very soon. So I would say overall progress, the level of investment we continue to make in the business, I think, will lead to significantly enhanced margins over time, which is our expectation for that business. And the commitment to the targets that we established for Investor Day for Uniforms are also still very much in place and very much on track.

Okay. And then as we look towards the spin, maybe remind us of what now needs to be done to get the spin over and done with and what's the timing of it?

Yes. We have filed the Form 10 and had initial commentary from the SEC. We responded to that actually very light initial commentary with the second private filing. We're working on filing with the IRS for the private letter ruling that would affirm its tax-free spin status. That process can take a few months, really dependent upon how fast the IRS responds. So we're working through all those technical details in terms of the filings. We continue to make all the structural changes and the -- have -- the business is very much prepared to operate independently. And so we've made the investments in people and resources adding key leadership to it. So really we're poised and ready to go fairly quickly once we have all the approvals and once we have all the process things done. We're keeping a watchful eye on the credit markets and the overall economic environment to judge what the best timing is. We're not married to a particular date. But we have in mind a kind of a range, if you will. But we're keeping a watchful eye on the markets to see what that best optimal timing is. The idea here, obviously, is to create value for our shareholders, and we want to do that at a time when the market receives that spin at the highest valuation. And so that's what we're working on. Tom, I don't know if you have anything you'd like to add to that.

No, perfectly summarized.

Okay. And then management, back office, that's all set right now.

Yes. It was always. As we've said all along, it was fairly separately run from the get-go. So there is some transition services to be cashed out, particularly within the IT-based platform environment. But that work continues to be underway. We're trying to minimize the TSA and the overlap. But inevitably, there will be some. But by and large, that's in good shape.

Perfect. Now I know you guys have been busy selling some things. You've sold AIM services, a portion of the Spurs. How do we think about additional asset sales going forward? Am I missing anything? Or what are you actually looking at to maybe monetize?

Yes. I think these were 2 very opportunistic sales. AIM services was a partnership we've been in for over 40 years. We'll continue to be partnered with Mitsui in other parts of the world. And I'm going to be in Tokyo next week, meeting with their CEO to talk about other opportunities and other partnership opportunities, if you will. And -- but it was a terrific asset. Obviously, we've got a very full price for it. It felt like the right decision. We would like to have owned 100% of AIM, but Mitsui was never going to let us own it. So it was the right decision to go ahead and divest it and get that very high price. They were very desirous of getting that deal done. So we took the opportunity to go ahead and use it to delever same with the Spurs transaction. We are not looking at other components of the business to divest. We have a couple of random assets yet on the books that we could think about the other -- the remaining interest in the Spurs, for example, and a couple of other small kind of joint venture opportunities. But nothing of the size and scale of AIM services. So yes, I think we're very close to being optimized from that perspective.

Okay. Perfect. And then how do we think about leverage here, either deleveraging? How do you achieve that? And then maybe also talk about uses of cash flow and capital allocation. What you're seeing there?

Yes. I think we'll continue to stay focused on delevering. I mean, we're moving down the leverage curve quite rapidly. There was that artificial peak a couple of years ago. We were probably 10x levered given that the toll that [indiscernible] we took on our covenant adjusted EBITDA. But as that's improved and we've worked with some of these strategic actions as well as the operating performance of the company, we've levered down and we'll be in that 4x, hopefully a little bit less than that by year-end. We initially set out a target at Analyst Day a couple of years ago to get below 3.5x. That looks very achievable, potentially earlier than we thought. So once we get down there, 3.5x, towards us 3x, and that includes continuing to support the organic growth of the business. Unfortunately, that doesn't take as much capital as we like it to take. We like to spend capital with our clients because it does give us term, does typically drive a higher margin. But we'll spend there first. We'll continue as we have to look at some tuck-in deals but nothing significant really on the horizon. So that leaves us with continuing to pay down debt, get below that 3.5x, like I said, probably towards the end of next year, fiscal '24. And then return to shareholder starts to enter the conversation. So we'll be happy to get there. but also keep our options open as we said, to support the organic growth as well as some M&A potential in between now and then.

Yes. I would just add that the Board is committed to the deleveraging story. And -- but they're also committed to optimizing shareholder returns. And we're going to reach a point where return of capital is the right decision for the board to make. And I think we'll be approaching it as Tom said, towards the end of next year, and we'll look at what those alternatives may be, whether it be stock buybacks, increasing dividends, who knows. But the earnings power of this company and the continued debt repayment capacity is very, very strong, and we're pleased with where we are, and we're making a lot of progress.

Okay. If anyone has a question, please put it in the chat again or e-mail me directly [email protected]. One question here is on the M&A side, what are you looking for as far as your tuck-in acquisitions? Are there any holes that you need to fill? So I know you kind of touched upon that a little bit, but if you could...

I'll start there, John. Like I said, internationally, not really any -- we don't want to plant any flags. So I don't think any new countries are in the scope. Certainly, building some density within the countries where internationally would be an opportunity. As you know, most international countries are fairly B&I dominant. So the opportunity to get into either Education, the Sports & Entertainment venues internationally and sort of broaden the base of the lines of business would be attractive to us. Again, within countries, where we're already operating in. Within the U.S., I think it's subsegments. It's things like Union Supply, which brought a commissary pick-and-pack capability to the corrections business but also has an opportunity to service some other lines of business. Next Level is a subset of health care within senior living and helping build that sub vertical. So I think it's really about nothing major, but trying to build up either the service capabilities within the current lines of business in the U.S. or broaden them internationally.

Okay. And you're happy with your purchasing scale, so nothing like Avendra or anything like that, right?

Well, we -- go ahead, John.

Sorry. So we would continue to make tuck-in acquisitions in the GPO space as well. And we have added some capability, particularly focused on certain segments of the GPO world. And we would continue to look for -- to add scale to that. Our primary growth methodology for Avendra is new sales, is approaching new customers and selling them the same way we sell new business and in the core business and the contract business. But we would look for opportunities that make sense. Obviously, it's very important to continue to build that scale as we add scale, it continues to lift our total purchasing and supply chain profitability as we reach higher and higher benchmarks of spend and that's very accretive to margins over time. So we'll continue to build that capacity as well.

Okay. Perfect. It looks like we only have about 30 seconds left. So I don't know if there's anything you want to say to wrap it up, but I have no more questions and there's no more questions from the line.

Terrific. Well, I would just say thank you for your support and interest in the company. Obviously, we're excited about the prospects of this organization. That's why Tom and I are here. When we rejoined a couple of years ago, we didn't know the pathway would be as quite as crooked as it has been given the impacts of COVID and then historically high inflation. But this is a great company with terrific potential and great people. So we are really excited about where we've -- where we are and where we're going. I guess it's the best way to put it.

Perfect. Thank you again. You guys have a good day. I'll get you guys your one-on-ones now. Take care.

Thank you.

Thanks Ian.