Aramark (ARMK) Earnings Call Transcript & Summary

I'm Andrew Steinerman. This is Stephanie Yee over there, Vice President of my equity research team. This is the business services track in the Aramark fireside chat, it's a 30-minute session. You can imagine we prepared our questions but we want it to be interactive. And I'll look for your hands to be raised. There is a mic that will go around if you're going to ask a question, but feel free to jump in. We think we capture the important questions, but just in case, it's always surely up to you. CFO, Tom Ondrof is with us. They just reported earnings a couple of days ago. It's surely a great time to engage. Tom has been with the transformation team at Aramark since 2020 and spent 24 years at Compass, which is the industry competitor. So this is just a very timely conversation. Also Scott Sullivan is with us at the conference today, who's in IR. Welcome back.

Good morning.

So I think the main discussion was in the conference call, when you look at the '24 guide, and this is the September year-end, so you're talking about September '24 now, that the employed margin expansion was about 40 basis points in '24. And that what I would call kind of a more measured progress than -- then I had the Organic revenue growth enhanced, everything is great on the top line. My question is, how would you describe kind of the 40 basis points of margin expansion? And if you could really talk about both the headwinds and the tailwinds in fiscal '24 as you see them at this time.

No, I appreciate that, and thanks for having us in today. Measured is probably a good word. If I step back, our guidance, to your point, is sort of a 40 to 45 bps margin improvement this year against our longer-range target, creates sort of a linear path to that goal. And I think, I guess people did expect it to be a little more front-loaded. That's quite possible for us. I mean we're -- we look at margin as a byproduct, not a driver. We drive the top line. We're about balance. John and I have preached that to the business since the beginning. We want both top line and bottom line. And again, margin is the byproduct to that. What could accelerate or tip that scale a little bit more front-loaded to fiscal '24? Again, we're measured. We're sort of going down the center of the fairway on our guidance. If inflation does continue to ease as we've seen in the second half of this year, we landed mid-single digits at the end of the year. And as we talked about on Tuesday, that's what we're expecting for the year.

5% to 6% really, so high end of mid-singles, right?

Yes. So if it tapers off consistently throughout the year, that's going to be a tailwind. And that -- our guidance contemplates on the high-end margins pushing 55 to 60 basis points. That's quite within the realm of possibilities, depending on what happens. The level of new business wins could also be either a tailwind or a headwind. Headwind if it's -- we have a massively great year with the start-up costs more than we expect outside the 4% to 5% range. Unfortunately, a bad year would be a tailwind on margin, so we don't want that. So a few factors in there, but again, trying to split the fairway, but something that's well above that sort of 40 to 45 basis points, given what the macro environment does is quite possible.

Right. And so when you talk about 5% to 6% cost inflation, that's a global food cost inflation in general or global food cost inflation on your basket?

It's on our basket. Yes.

Okay. And is there any way as an outsider that we could track that? Like Alex puts together food at home, and that's basically what we track within CPI. Like is there any way we could do that better? Meaning you have your basket, but you don't really show it to me.

It is unique because we are a client-driven business. So it's unique to what those clients demand of us. We do have flexibility where we're giving complete control, less so in cost-plus type contracts. Food away from home, it would be in aggregate, I think, and food away-from-home is a measure that I think probably best represents it, but nothing is perfect as we've talked about before.

Right. And are there other tailwinds going on, like maybe speak about the growth of your GPO or whatever you think are tailwinds that would help '24, this is a good time to talk about it.

Well, that's what we're excited about. It's not just '24 but beyond and why we feel so confident in the longer-term outlook we've put in place based off our Analyst Day goals from a couple of years ago. We're still very committed to those and very confident in those once we adjusted for the spin of the uniform business. But the tailwinds, we've sort of put into 5 buckets. We talked about the price lag benefit for the -- specifically for the corrections and higher ed businesses that have very distinct pricing opportunities throughout the year once or twice a year. The balance of our business, fortunately, has pricing opportunities throughout the year. But we're not a business where you can just push a button and raise prices like the high street, Main Street retailers can do. Ours is a discussion with clients and a lot of data and trying to show value to our clients. So that, for instance, if prices -- if inflation is 5%, we want to go to the client ask for maybe 3%, and we get the others through operational efficiency because that's where we drive value and show value to our clients. So we will get opportunities to enhance profitability and margin if inflation continues to ease and that pricing comes through at a higher level. We've got opportunity with our new business maturity. We've gone from basically, as you know, Andrew, a standstill 4 years ago where we had no net growth to a step change over the last 3 years. That carries with it some inefficiencies. New business typically comes on and dilutive to overall margins and then builds as we have it and run it more efficiently over the course of 1, 2, 3 years or getting to more of a cruising speed on that step change of net growth. So start-up costs sort of just lap each other and aren't really a relevant thing and contract maturity of older contracts offset the newer ones. But we'll get benefit there. But the three main drivers, and will continue this year and beyond, are our supply chain leverage as we build out our GPO, which we acquired just before COVID about 18 months before. We really, truly, for the first time, have an opportunity to drive the value that, that GPO brings to the organization. And that's coupled with the growth that the business is developing. Because with the GPO, it's not that you just have volume, it's that you have growth is what matters to manufacturers and suppliers. $16 billion of volume that our GPO controls is important, but it's more important that, that becomes $17 billion, and $18 billion, and $19 billion over the next few years with suppliers when we're negotiating with them. And that's what we have for the first time because, again, we weren't growing before. We also have an opportunity to get back our unit level contribution, which really got blown up during COVID. We had great disciplines prior to '19 in the unit. Very good compliance on products, from right products, right suppliers. We had good labor disciplines, not using temp labor, managing schedules and hours, disciplines on other directs in the unit. If you think about it, napkins and paper products, COVID blew all that up. We had to buy products from wherever. We had to -- we were using temporary labor because we just needed people, and the amount of paper and product that got into units during COVID was crazy, single-use forks, knives and all that sort of stuff. So we're getting all that out of the system and getting back to the deal points and compliance both on labor scheduling, on products, getting everything back. So that unit profitability continues to build and sort of as a stealth opportunity for us. It was a bit this year, but it will be more so in '24 and beyond. So we get back to those basics at the unit. And then the last benefit really is the SG&A containment. As a practice, I like to hold our business accountable to growing their SG&A the above unit cost at half the rate of revenue. So if we're growing 6%, we would grow SG&A 3%. We have the opportunity now post spin, and we've already started in on it to really look at everything we're doing and contain that. I think we can contain that to 0 over the next few years. And that operating leverage is quite significant versus even a 3% growth off 6%. So those 5 variables are drivers certainly for '24 but '25, '26 and beyond.

Right. So say again, you can hold SG&A flat for the next couple of years because you're taking out stranded costs and you're adding in, let's just say normal SG&A?

We're just looking at different ways to do, to run the business a little bit better and every day, and I think that we can be a little more aggressive post spin than maybe we were prior to COVID-19.

Right. I think you kind of just answered this question by saying we also have to get efficiencies. But I just -- my question is, is this a business with pricing power? I know you said, hey, we're assuming 5% to 6% food inflation. My first question is like when you add all your input costs, including labor, what's your input cost inflation? And how does that compare against the 3% to 4% that you're going to get on price? Like I think you said we don't fully get it in price.

We don't. And if you combine labor, it would be the overall basket of inflation. Labor food would be less, less than lower part of that mid-single digit. So getting 3% to 4% pricing still leaves you with a bit of a gap. And again, that's the value gap in our mind. That's what we have to go out and show the client, hey, we're an efficient operator, we'll be able to do this for you. Because otherwise, if we just hand them a bill for the -- for inflation...

Where's your value.

They can do it.

Right. Okay. And this is always, this isn't particularly now you're saying you always have to do that like a point of efficiency? Okay. That makes sense to me. What really surprised me and maybe you could be like Andrew who's been coming for a long time. But your largest vertical now is Sports, Leisure & Corrections. I mean it is kind of a mouthful to say Sports, Leisure & Corrections because there's really three businesses. But it's 30% of Europe [ SSS ]. Could you just go through, help us understand it, where is all that growth coming from? Is it really all of those subsegments? And my other question is, is this business more cyclical now, and I'm really thinking about kind of the sports and leisure part of the business because I think it's like you've really picked up spend per capita there and how that might fare in a more moderate, let's call it, leisure environment, which isn't the case now?

Yes. I don't think it's more cyclical. I mean it's around the edges. We certainly have the sports entertainment business has really boomed the last couple of years. And it's a variety of factors. Cash coming out of those units has been something we've been trying -- wanting for years because it does raise the per caps when people are using credit card versus cash, it becomes a bit of play money, I think, for people. But we've also done more to really just drive the customer experience, make things easier, food lockers at a venue where you can order from your seat, even if you're not sitting down by the dugout on a baseball game, you can order from your seat, when your food is ready, it's in a locker and it pings you and you go get it. You don't have to stand in line. So things that just make the experience easier, the queues shorter. And so that's grown, but I don't think it's tipped the balance that the business is any more cyclical than it's been. In terms of growth across those 3 verticals, certainly, sports has had a good couple of years. Merlin, the U.S. version or a portion of Merlin is in that -- no, it's actually in sports. That's the group that been running it. So you have to ask John question. Destinations. Not so much. They tend to run -- they run national parks and whatnot. And their bid cycles tend to come in cycles. So I think the last couple of years, for destinations hasn't been as much, but there's some good pipeline opportunity for them over the next two years.

And we've been talking about that pipeline and National Flex for awhile.

I know. Talk to [ MBS ] for me.

I'm just saying like, yes, when is that going to get realized?

Well, that's -- they've just been pushing off the RFP processes. So really nothing much has moved here recently.

And you're still confident about you win your -- more than your fair share of products when it does move.

We already have more than our fair share but we'll continue to. I think corrections has grown well as well. I mean we've noticed we -- Missouri was noted in our earnings release and a few others in the 2 years before that. So I think corrections and Sports & Entertainment have grown faster in destinations. But as you've noted, the group in total has moved forward quite nicely.

Where are we in B&I? Most -- it's funny. It's like here at JPMorgan, we're a 5-day a week shop. I assume there's not that many places still that are 5-day a week shop. My compliance has been 100%. And so where are we both in terms of profitability and the profitability, it's talked about those volumes. Are we still going to be talking about volume recovery? Or do you think we're now at a steady state? And is B&I back to a typical margin for B&I is mid-single digits? Like are we back like as we start the year here this fiscal year, are we in mid-single digits for B&I?

Yes. So tough to pull apart this many years later, what exactly...

I meant U.S.

Yes, in the U.S., but tough to pull apart what really is COVID recovery versus net growth that we've had and we've had some very good net growth in B&I. But I think as you wash -- if you wash away all the details, the B&I business will be bigger in FY '24 than it was in FY '19 which is significant. And that's probably with some return to work issues that never did come back. But we've had increased participation as we sort of suspected when you're in the office 3 days a week or 2 days a week, you eat here -- so we almost are getting 100% participation when you're in.

And you think that's sticky, right?

That seems sticky versus 50% participation before was the average when people were in 5 days a week. So that's sort of leveled out. But the net growth has been substantial, which is great. So I think we're going to have a business that's bigger than it was in '19. In terms of the margin, the phenomenon I talked about with that in-unit contribution discipline, the margin is not quite back yet, but has that opportunity as we rebuild those disciplines that we had to relax during COVID. So that's another part of the FY '24 profit margin journey.

Right. Will you get B&I back to mid-single-digit margins right throughout the year by the time we finish the year?

I think very close.

You talked about some repositioning the portfolio in the Next Level acquisition, which is senior living. It was really -- senior living was a new vertical for them when they did this 2021 acquisition. It just feels like you did a '21 acquisition. Here, you're talking about repositioning. Is something off?

No, not at all. We went in eyes wide open. Next Level was a senior living business. Very attractive services.

Food services?

Food services, doesn't own the properties or anything like that. And very, very large under-penetrated and self-opt-oriented business, $80 billion plus sort of market opportunity. So a very exciting opportunity to be in which we weren't in. We wanted to get a beachhead. Next Level had been built over very quickly over about 4 or 5 years through a private equity group. And we knew in due diligence that there were some clients either because of far-flung geography or sort of financial positioning that we weren't going to be wanting to be long-term partners with. So they had an earn-out, as you know, through the end of last year, the calendar last year. So we were a little bit of hands off to that point because we wanted to let them do their thing and try to earn-out. So starting in January, we've really spent time getting the base of that business, which is primarily skilled nursing and Medicare, Medicaid reimbursement oriented pared down to a core of customers that we really, really want to move forward with and our good partners. And then we've added 4 salespeople primarily focused on the CCRC side, which is the higher-end private pay venues. We've sold a couple right at the end of the year and have got good momentum going into the new year with that. So just sort of building this business from a firmer base and we're excited about where that's going to go from here.

Okay. So is fiscal '24 a year of growth or?

I think it will end up being a year of growth for them marginally and then more so as we go forward.

We've got about 10 minutes, 10 and a half minutes left to questions from the audience. There has to be questions, you kidding me?

So I know you mentioned that you have -- your expected inflation is around 5% to 6%. Are you including any improvement in the guide? Or are you expecting that even if there's any deceleration, then that could be a kind of improvement on top?

Well, that's sort of where the range is. So if we have sort of sharp deceleration of inflation throughout the year, the guide contemplates sort of up to 60 bps -- close to 60 bps of margin improvement, 20% AOI growth, I think that's what's going to be the big driver to take you up to that end of the range. Again, we're trying to sort of split the middle of the fairway. And again, if there's a reacceleration of inflation, that's going to sort of take you down. Because one of the things to contemplate is that in the 7% to 9% revenue we've gotten pricing that's going to roll into this year, last year, but then we're also talking about pricing increases with our clients now. So in our revenue guide of 7% to 9%, it was comprised of 4% to 5% of new contract wins and 3% to 4% of pricing. If we don't need that pricing because inflation is decelerating, we're going to be on the lower end of the revenue, but it's going to help the bottom line. So we'll probably move up to the top end of the AOI guidance and therefore, the margin is going move up to the top end. That makes sense?

And like do you feel like the top end of your margin guide, I know you booked it up to 60 basis points. Do you feel like that's a cap like if inflation continues to decelerate, margins can show upside, right?

Yes. I mean, like you said, we're sort of in that 40 to 45 bps margin down the middle of the fairway, midpoint of the guidance, that's okay, now let's see what happens. We're managing the business sustainably for the long run. We -- John and I value and the business value balance top and bottom line. We'll continue to do that. And a couple of variables, like I said, outsized net growth or undersized net growth may influence that a little bit. And the inflation rate may influence that to the top or the bottom. But we set a guidance that sort of captures what we think may be either side of the fairway, if it's incredibly sharp either way, that may have us reassessing things.

I like the way you said this year is 40 to 45 basis points middle of the fairway. And then to get to the '26 goals, it's sort of like a linear progression, and you're saying similar in '25 and '26. Do you feel like your margin targets for '26 are a cap?

Absolutely not. I mean we -- again, a sharp deceleration of inflation. We certainly assume it will ease over the next three years, but the sharper, quicker deceleration this year will help move that forward, I think, a bit faster than how aggressive do we get on SG&A containment, how quickly can we sort of get the disciplines back in the units, all those things work together to say we'll move to and through those numbers.

Okay, so if you said a linear path, you say 40% to 45% this year, that only gets you to the bottom end of the '26. I just wanted to make sure that, that to and through is still there.

Absolutely. Still there.

Other questions?

Just a follow-up on that. So you mentioned that inflation is actually if it decels further, then maybe you don't reach the 4% -- the higher end of the pricing guide. So how -- considering I think you mentioned that you were experiencing higher inflation previously and now you're going to benefit from passing that pricing to your clients, but you don't expect to give back pricing. I think that's what you've mentioned in your last earnings call. So is that changing? Do you see pressure from clients coming in where you may not be able to pass on that same level of pricing and have that margin expansion?

Well, that's -- again, I think if I'm following your question, we've assumed sort of 3% to 4% pricing, some of it which we've already gotten as we roll into this year. If inflation is decelerating, we're not going to get what we thought. We won't need the 3% to 4% pricing, and we won't get it from clients because the data won't support it. So that's why our revenue may slip more to the bottom end of the range. But that's going to help the bottom line because of the pricing we've already gotten as I sort of talked through. But again, I think we've captured that in our guidance, those sort of variables. The only thing I would caveat is if there's sharp either way, then we may reevaluate them. I mean if we get true deflation, then it could be even a bigger benefit if there's a sharp reacceleration then we'd have to readdress that, too. But I don't think if there was a sub question in there about giving pricing back? No, that's -- I've not seen that in my 30 years in the industry.

Let's talk about net new. In past fiscal year, fiscal year '23, net new was 4.3% of the trailing revenues. And the company made a comment, which I think sounds kind of early to make that you've always signaled confidence in '24 net new to be 4% to 5% of trailing revenues. Like what gives you so much confidence? Is this sort of like an awkward period of time, like a lot of signings get done in the spring? Or do you already have some stuff in the bag signed like let's call it in October and November to make such a confident statement about this year's net new?

We do. And it's one of the beauties of the business that you do have great visibility into the RFP process and hello-to-contract, as we call it and the discipline that we have in the sales process that we can make those statements. So we said two years ago, coming off 4 to 5 years of average zero net growth for Aramark from fiscal '15 to '19, we made a pretty bold statement in '21 that said we're going to grow 4% to 5% net growth for the medium term, sort of through the next 4 years or so. And we are achieving that and we achieved it last -- we were above it last year with Merlin. We were up about 5.3%, but the largest contract in the company's history. But even without that, we were in the low 4s. This year, we're at 4.3%. And for '24, we expect to be in that 4% to 5% range again. Comfortably, to your point, we booked Boston Children's in October, 3 weeks after, which was a nice win for us. John mentioned that on Tuesday. We have some other verbals that we'd love to detail, but not quite yet. We haven't finished the negotiations, a significant win in the U.K., also most likely a K-12 district here in The States. So good momentum in the first quarter, and we feel good about that statement for the year.

Right. The answer is that you already have good momentum in net new in the first quarter. Other questions?

Two questions. One on pricing is the first one. You mentioned that you'll pass along 50% of your -- of inflation. I think that's what I heard you say.

They probably -- probably a little higher.

A little higher. Do you know if your customers are doing the same thing as you? And as -- and are your supply chains doing the same thing as you? Because it's an interesting -- I love the idea. So it's certainly a value added, but in the end, if there's somebody in the middle of these value chains who is operating differently in some respects, it creates a pressure and a disadvantage to that person in the value chain.

Yes. I think in a way, the way our model works, if I'm following your question is we're sort of taking that. So in order to recover our cost, if we were losing $5 because of inflation. If we say to the client, we'd like you to give us $3 or $4 of those dollars, we then take the initiative to find the other dollar through other mechanisms in the unit so that we recover our profit without passing it on. So I don't think it then has that ripple effect. The customer is not -- they actually benefit because they're only -- they're getting less inflation or less cost at the end. And then down the supply chain, we deal with them separately in terms of trying to manage that cost.

So you're trying to treat your supply chain as if it is intended to hit your targets about how you're going to manage pricing?

We are. I mean, it gets a little -- I mean, we would go back to them and negotiate. We would -- if they're trying to get us an increase of $4, we're going to try negotiate $3. So it ripples up and down the chain, if that makes sense.

Okay. Other question has to do post the spinoff of the uniform business. You probably had certain hypotheses that you were going to incorporate into new business on a stand-alone basis. Can you tell us what some of those hypotheses are proving right or wrong in terms about how you're going to manage for margin profiles or sales force productivity or anything in essence that you made the assumption about doing the spinoff and post-spinoff? Those things are showing up as you thought on metrics and performance for the food service business.

Yes -- no, I don't think the spins had anything to do with those types of things in terms of the net growth. 4% to 5% was something we stated, all of our Analyst Day projections in '21 included uniforms. So we haven't come off that 4% to 5% net growth, which is driven by sales resources, sales productivity metrics, all those things. We didn't lower it because we spun off Uniforms or raise it really. Margin profile, I think that there were two very distinct businesses in terms of margin profile. Uniforms is a double-digit margin business, food service a little narrower. But ultimately, the growth profile, I think, is phenomenal in the marketplace in food services. So not a lot of difference between pre and post spin in terms of the metrics we were losing -- or looking at, which is, again, a bit of a testament to how different and separate the businesses were run.

Okay. Perfect, Tom. That's a wonderful place to stop. Thank you so much for the dialogue. We appreciate it.

Thank you.