ARMK - Vestis Fiscal Q4: Positive Earnings Signs Post Its Spinoff

2023-11-29 16:23:53 ET

Summary

• Vestis Corporation is a $2.8 billion business that was spun off from Aramark, with half of its sales coming from uniforms and workwear.
• The company aims to outgrow its peers with mid- to high-single-digit sales increases and EBITDA margins of 18-20%, lofty ambitions which if achieved could create real value.
• Vestis' most recent results showed a solid performance, yet this needs to be replicated in the coming quarters, as not all separation questions have been answered here.

When Vestis Corporation ( VSTS ) was spun off from Aramark ( ARMK ) early in October, I took a look at prospects for the business and its shares.

Vestis is the former uniform and workplace business from Aramark, now separated from the core food distribution business, with no (longer) synergies seen between both business lines. The lack of synergies and potential value to be created from having more focused operations, which can run make their own capital allocation decisions, were key drivers behind the move.

Following the spinoff, investors in Aramark were to receive half a share in Vestis for every share which they owned in Aramark. As I required more insights in the performance post the spinoff, the fourth quarter results look quite solid, but I still find it too early to get involved.

Before considering a position, I require a few more insights into the business, although the early signs look quite positive.

On Vestis

Vestis is a $2.7 billion business which generates half of sales from uniforms and workwear, complemented by revenues which are generated from the sale and distribution of towels, floor care, linen service, restroom supply services, etc. About 90% of sales are generated in the U.S., with Canada being responsible for the remainder of revenues.

The business is quite substantial in terms of size, employing over 20,000 workers which are serving some 300,000 customer locations, as the company claims that it holds a 6% market share in the industrial service offering industry, making it the number #2 operator in a near $50 billion industry.

Riding the continued outsourcing and specializing trend, Vestis aims to outgrow its peers, seeing mid- to high-single digit increases in sales, with EBITDA margins seen at 18-20% of sales.

A $2.59 billion business in 2019 saw sales fall to $2.41 billion in 2021 amidst the impact of the pandemic, and the impact on many of its customers, as revenues recovered to $2.64 billion in 2022. This essentially shows that no revenue growth was seen between 2019 and 2022, certainly if we consider the inflation seen in the meantime. Adjusted operating profits of $266 million in 2022 were largely at par with the 2019 numbers, with EBITDA of $373 million working down to margins equal to about 14% of sales.

With mid-single digit revenue growth seen in the first three quarters of the year, revenues were seen around $2.8 billion in 2023, with margins seen around 10%, as a $270 million operating profit number looks realistic. Factoring in $20-$25 million in costs to becoming an independent public business, the company will see operating profits of around a quarter of a billion, at least that was my belief upon the time of the spin-off.

These earnings are badly needed as pro forma net debt was seen around $1.47 billion, with EBITDA seen at $373 million, translating into a 4 times leverage ratio. Believing that interest costs come in around $70 million, pre-tax profits of $180 million come down to $135 million if we factor in a 25% tax rate. With a 131 million share count for the business, I believed that earnings are seen around a dollar per share.

This would translate into mid-teens earnings multiples with shares trading around the $17 mark upon the spinoff, while net debt was quite elevated, certainly as there are some moving parts in any spinoff investment case. This did not to make me very upbeat, although the long term margin potential could unleash great potential, which remains a question mark of course. Given this situation, I decided to place the shares on my watch list, but I did not get involved just yet.

Trading Stagnant

Since the spinoff, shares of Vestis have pretty much traded rangebound between $14 and $17 per share, now trading at the high end of the range following the release of the first quarter earnings report post the spinoff.

By the end of November, Vestis posted its fiscal fourth quarter results and thereby full year results for 2023. Fourth quarter sales rose by nearly 5% to $716 million, a growth pace which is in line with the full year growth rates. It was comforting to see operating profits rise from nearly $31 million to nearly $58 million for the quarter, a strong result, attributed to strong operating leverage.

Net debt ticked down to $1.45 billion, although that this number kindly excludes some operating and financial lease liabilities. Full year EBITDA was reported at $404 million, pushing down leverage ratios to 3.6 times, again excluding some financial and operating lease liabilities.

And Now?

For the current fiscal year 2024, Vestis believes that revenues are seen up 4.0% to 4.5%. EBITDA margins, which came in at 14.3% in 2023, are seen replicated in 2024 (or come in even higher). An anticipated 50-60 basis point margin expansion is set to offset an expected $15-$18 million incremental public costs, due to the separation of the business.

If we look at the current adjusted operating profits of $293 million, subtract $15 million in stock-based compensation expenses, we end up with adjusted operating profits of $278 million, a bit higher than I believed at the time of the separation. Still assuming some $70 million in interest expenses (to be verified in the coming quarters) I still see a roadmap for earnings around $150 million, for earnings of around $1.15 per share. Trading at $17, multiples are seen around 14-15 times earnings, as leverage has come in a bit lower than expected.

The other good news is that of anticipated gradual sales and margin growth in 2024. The uncertainty of the separation of the business and added associated overhead costs, it seems to be working out reasonably well. In fact, investors can furthermore receive $0.035 per share in quarterly dividends, for a near 1% dividend yield, as deleveraging remains an area of focus here.

All this looks positive, but there are still some question marks about Vestis Corporation. This means that I am not yet willing to enter a position, but I will look forward with great interest to the first quarter results. This will be the first real quarter in which Vestis Corporation has been separated, to learn more about the business before reconsidering a current neutral stance.

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