Summary
- A reader asked me to take a look at Aramark, and I'm happy to do so. The company has a theoretical appeal based on its portfolio and fundamentals.
- However, Aramark has been facing difficulties, and EPS has been flat for a few years, even negative.
- We'll look at what the upside is for the company, and how we can consider it here - whether it's a "Buy" or not.
Dear readers,
It's time, based on a reader request, to take a look at the company Aramark ( ARMK ). For those of you who don't know what Aramark does, the company essentially does most things in facility services, including food, uniform, and general services.
The company isn't just found in the US - it's global - and in this article, we'll look at how we can consider Aramark as a whole.
Aramark - What does the company do?
So - Aramark.
The company is a world-leading and massive provider of food, facilities, and uniform services to customers typically found in healthcare, business, industry, correctional facilities, sports, and education.
The company's by-far largest market is the USA, but with a supplementary 18-country broad footprint. The company holds a top-3 position in food and facilities, with a #2 in uniform services as well as a top 3 in food services internationally. The company has nearly a quarter million employees and partners with customers to serve millions of consumers who are typically patients, students, employees, sports fans, and "guests". You'll note that in the company's 10-K the term "inmate" is conspicuously absent - so let's clarify that here.
Aramark serves a lot of inmates - remember that, because we'll be looking more at that.
From a high level, the company provides a three-segment operating structure - FSS United States, FSS International, and a broad, international Uniform segment. FSS United States is more than 50% of annual sales here.
The company has a history going back over 60 years and has been growing both organically and inorganically since then. The company was actually through a management buyout in 1984 when the company management and employees increased ownership to over 90%, which lead in turn to the 2001 IPO. The company was delisted 6 years later as it went private but was re-listed back in 2013. A lot of different moves for this company in the past few years.
The company has a moat. In many of the locations it serves, Aramark has exclusive rights to provide food and beverage services. The company is also responsible for hiring, training, and supervising the majority of the associated personnel, in addition to managing payables and receivables/supplies and management for the items and meals sold. The company also provides plant operation, maintenance, housekeeping, energy management, groundskeeping, and general services.
Purchasing of ingredients and foodstuffs is done nationally, and due to the huge volumes purchased, the company receives substantial volume discounts. The company purchases food through businesses like Sysco ( SYY ), US Foods (USFD), and others. Sysco is the company's primary food distribution partner. Contracts vary - from indefinite agreements to fixed terms. The company's agreement with Sysco has been in place for over 40 years, with the company supplying more than 50% of Aramark's food.
The company addresses a $540B TAM, with a $215B food market alone and another $285B in Facilities. The company's current market share is comparatively very small, with room for further consolidation.
The pandemic was a difficult period for Aramark, and the company had to adapt in order to survive. It added salespeople, revised commission plans, changed leadership, and reviewed its overall pipelines. It optimized its supply chain and permanently eliminated millions in above-unit costs.
By FY25, the company targets being a completely different business than it is today, with revenues of over $20B, margins of up to 7.5%, and annual EPS of upward of $3.65 with a no higher than 3.5x Leverage. COVID-19 recovery and annual growth from new business, pricing and volume, and optimizations will deliver this growth. The company, as of late 2021, still had billions in unrecovered COVID-19 volumes, which are slowly coming back online again. This is the walk to that 2025E target that the company is seeing.
One of the risks to the company is that Aramark's ability to raise its prices is dictated by individual contract terms, often requiring consent from the contract holder to raise prices on merchandise, food, or drink within a particular facility. These contracts vary in length, but most of them are over a year and are fixed. This means Aramark's ability to adjust for sudden inflationary spikes is relatively limited - which is also a big part of what is causing the current downside to the company.
The company is also obliged, in case of new contracts (especially in the case of sporting arenas or convention centers), to make large up-front investments, leaving the company with some financial burdens here.
If you're familiar with my articles, you know that I don't often discuss when a company has scandals or complaints about its practices. But with Aramark, ignoring this would be equal to ignoring a business or investment downside. This is how serious these issues have been seen as being.
Aramark has a long history of controversies - including but not limited to labor law violations , and food safety issues (with substandard food for inmates that literally made people sick and was maggot-infested ). The term of "literally serving garbage" has been attributed to Aramark more than once, with quotes like this:
It also noted that Aramark has in the past "underfed inmates and fed them dog food, worms and scraps of food from old meals" and argued that the university should reconsider its relationship with the food services contractor in light of these ethical issues.
(Source: The Cavalier Daily )
Notable school clients include the Chicago Public Schools, various correctional facilities, and the entire Ohio Department of Rehabilitation and Correction. Let's not beat the business issues to death, and simply confirm that the company has some work to do with regard to its practices and images, and it pays off to follow this as an investor. I'm all for cost control, but not at the expense of breaking contracts - and serving spoiled food goes right under that sort of issue.
Recent results confirm the continuation of the recovery.
The company recorded a solid activity increase across the company portfolio, with significant recovery in sports, education, business/industry, healthcare, and in facilities services. Uniforms are up as well, driven by rental revenue increases.
Revenues weren't the only improvements - margins improved as well, with a 4.4% YoY increase and FCF grows along with the rest of the business. The full-year expectations have been confirmed.
The company also seeks to deliver additional value by slicing off the uniform services, which aren't burdened by the company's food issues, into its own distinct businesses with separate targets.
Overall, I like the company's plans for value creation, and consider them to be solid. However, time will tell exactly how this will turn out - and valuation remains key to investing in the business.
I do want to point out, however, that the uniform service segment is significantly more attractive as a business and with its history. This business has a better contract model, not the same risks, already a leading footprint, and excellent customer retention rates, with wide customer geography.
Let's look at Aramark's current valuation and see when we can invest in the business.
Aramark Valuation
The company's valuation is problematic. Why? Because EPS has been flatlining for years, which is distorting the current multiples. Even though the company's EPS is slated to recover to $1.17 for 2022, and even though the company did not cancel or cut the dividend despite COVID-19, we do see the valuation as somewhat problematic here, because there's only a limited impact from the pandemic.
F.A.S.T. Graphs Aramark (F.A.S.T. graphs)
Yes, there's some upside to be had based on EPS expansion from forecasts. But this does not take into consideration that the company is fundamentally sub-par due to a BB- credit - not even investment-grade, and actually significantly below the level we're typically looking for.
Not exactly favorable when compared to most of the investments we typically look at.
The company, outside of the pandemic, averages an 18-19x P/E range. When we apply this to the current 2023-2024 forecasts, this gives us an upside between 17-20% annually.
F.A.S.T. Graphs Aramark Upside (F.A.S.T. Graphs)
I'm doubtful about this not just because of the company's credit rating, but also due to the forecast accuracy with a near 1-year 50% miss ratio (with a 10% margin of error), which means that this upside, based on statistics, is uncertain.
Aside from this, we also have some dividend issues. The yield is only 1.23%, which is well below inflation. To that, we have the fact that dividend growth for this company is very slow. You really can't expect the business to grow the payout all that quickly.
These negatives, or risks, are relatively significant here - at least as I see them. Because Aramark does need to be put into context to other investments, and given its volatility, I don't see a 19-20x P/E to be a workable premium. In layman's terms, it's too much - way too much for me.
The management's tone is positive. I won't argue that the future is positive. Based on the company's recent performance, any EPS growth would be positive - and I do like some of the plans that are being worked for Aramark. But it's not enough for me to accept this sort of premium.
Aramark bulls focus on this positive risk/reward ratio, as they would put it. I don't deny that this positive ratio does exist - I just don't think it's as significant or as high as some would have you believe. A 15-20% annual RoR with a 1.2% yield isn't all that great when you see the forecast accuracy, or what else is available on the market at a cheap price.
Remember, we're in a market situation where many things are actually quite cheap. Many quality companies are on sale.
And someone is asking us to consider Aramark in such a situation?
Certainly, I could - but not at this multiple.
S&P Global analysts give the company the following targets.
TIKR.com Aramark (TIKR.com/S&P Global)
Little change in a year or so, as you can see. Analysts tend to assign a bit of a premium to the business - a premium that I do not necessarily agree with. That premium tends to be between 10 and 15%. We're currently at a 15% undervaluation to that average target. That tells me that the company is in no real way undervalued here, and we should be somewhat more careful here.
At the same time, I don't want to take away from the forecasts. Take a look at what S&P Global is forecasting here.
Aramark EPS forecast (S&P Global)
At a cheaper multiple, I would definitely be interested here.
How cheap, given today's market?
No higher than $28/share, or a normalized 14-15x P/E. And that, I believe, is being fairly generous with the company's labor and food issues, as well as the EPS drop during COVID-19.
Thesis
My thesis for Aramark is as follows:
- The company is a theoretically attractive business with an eye for food service, uniforms, and various sorts of services for organizations that are attractive customers (education, sports, corrections, etc.). However, the company is hampered by poor fundamentals and a surprisingly deep reputation for food quality negligence and labor law violations that need to be seriously considered prior to invest.
- At the right valuation, this company can deliver you an upside of no less than 15-20% annually, and even more attractive ones. But this requires you to take a substantial risk at this time, which is not present in more qualitative investments.
- Because of these factors, I consider Aramark to be a "HOLD" at this time, and I go no higher than $28/share in my price target.
Remember, I'm all about :
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Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
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If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
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If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
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I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them.
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
For further details see:
Aramark: Insufficient Upside And Fundamentals; I'm At A 'Hold'