ARMK - Aramark: Not Making A Mark

Summary

• Aramark has seen accelerated growth in recent times and better margins, after a tough period.
• The company has seen modest achievements since its public offering a decade ago.
• High leverage ratios and high earnings multiples (based on subpar margins) make it hard to be appealed to the shares here.

I have not covered Aramark ( ARMK ) since its former private equity owners brought the company public late in 2013. Shares of the leading provider of food, facilities and uniform services to a wide range of industries rose 13% on their first day of trading, as I did not share that optimism.

A Recap

Founded in 1959, Aramark provides a range of services previously mentioned to a diverse group of organizations, including education, healthcare, sports and leisure organizations. The company catered meals to millions of students, catered over a hundred million sport fans, offered uniforms to 2 million people a day, creating a huge and diversified service business.

The company went public at $20 per share, as shares rose to the $24 mark on the first day of trading, granting the company an equity valuation around $5.5 billion. The company organized its business across three reported businesses, of which North America was responsible for two-third of revenues, with the remainder of sales derived from international activities and uniform segment.

Aramark generated $13.5 billion in revenues in 2012 on which net earnings were posted at just $104 million, as slim margins were in part the result of interest payments which approximated nearly half a billion on a substantial net debt load of $6.1 billion, as the IPO would provide over half a billion in proceeds to pay off some of that expensive debt.

With an enterprise value of around 11 billion, valuations looked very high, in part because of the high leverage situation.

A Very Boring Decade

In the decade long period since the public offering, share of Aramark have steadily risen to $39 at this moment of writing, albeit that investors have seen huge volatility around the pandemic of course. Compared to the $24 price at the first day of trading, the cumulative 60% returns look relatively modest given that we are nearly a decade further in time, amidst a very modest dividend yield.

Forwarding to November of last year, the company posted its 2022 results. Full year sales had grown to $16.3 billion, as the $3 billion increase from 2013 hardly keeps up with inflation, if at all. These revenues are still generated among the three segments with the US operations responsible for $10 billion in sales, international activities responsible for $3.7 billion in sales and uniforms responsible for $2.6 billion in sales. Overall operating margins remain slim at 3.9%, equal to $628 million with adjusted operating profits totaling $780 million.

So with growth being rather modest, with no real growth seen adjusted for inflation, we have to recognize that investors have seen some dilution as well. The company now has 260 million shares outstanding, about thirty million more than the time of the public offering, making that on a per-share basis, there really has been a reduction in performance. Worse, the company ended the year with a $7.0 billion net debt load, equal to 5.3 times EBITDA based on the covenant adjusted EBITDA number of $1.3 billion.

The company posted GAAP earnings of just $0.75 per share with adjusted earnings posted at $1.16 per share, as even the adjusted earnings numbers still translate into huge valuation multiples. Part of the optimism comes as the company sees 11-13% sales growth, with adjusted operating earnings seen up 34-39%.

Tackling Leverage - Modestly

Early in February, Aramark has reached a deal to divest its 50% equity stake in AIM Services to Mitsui & Co Ltd in a $535 million deal, a smaller deal, but it would reduce pro forma net debt to about $6.5 billion. The first quarter results learned that Aramark did not consolidate these activities, as the ownership stake contributed $30 million in pre-tax earnings pre-Covid-19.

First quarter results did show a big increase in sales, up nearly 17% to $4.6 billion with inflation being a key driver behind this growth of course. Operating earnings rose from $140 million to $200 million, marking some margin progress as net earnings of $74 million worked down to $0.28 per share, with adjusted earnings posted at $0.41 per share.

Poor working capital conversion made that net debt actually rise to $7.8 billion, albeit that covenant adjusted EBITDA has risen to $1.4 billion on a trailing basis. With normalization of the working capital need and the proceeds from the divestment, leverage is seen at 4.0 times by year end, up from over 5 times now.

Even if this is achieved, leverage is still quite high and even if we annualize the current $0.41 per share number, multiples are still very demanding at 25 times earnings. The promise of the business is of course that it could return to 5-6% operating margins, as was the case in the mid 2010s.

If that happens, a 5-6% margin could result in operating earnings around a billion at the midpoint of the range. After applying a 5% cost of debt on $7 billion in net debt and a 25% tax rate, net earnings of half a billion would translate into earnings of $2 per share. Even if this is realistic, which is a big if, shares trade at 20 times earnings amidst 4 times leverage, which make the valuation very full.

Given this valuation and the relative modest achievements over the past decade, I find it very easy to avoid the shares here, at current levels.

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