On the first trading day of October, Aramark (NYSE:ARMK) closed on the spin-off of its uniform and workplace business supplies called Vestis (NYSE:VSTS). Investors in Aramark would receive one (1) share for every two (2) shares held in Aramark.
The spinoff would separate the uniform workplace business from the core food distribution business, as apparently there are not that many synergies with two companies which control their corporate strategy (including capital allocation) destined to create more value separately.
While the spinoff is an interesting move, and I am keen to keep a close eye on Vestis going forward, I see no reason to get involved with the stock here.
About Vestis
In mid-September, Vestis introduced itself to the investment audience. Vestis is a $2.7 billion business which generates nearly half of its sales from uniforms and workwear. This is complemented by revenues generated from the sale and/or distribution of towels, aprons, floor care, linen services, restroom supply services and even first-aid safety products. Some 90% of revenues are generated in the U.S., with the remainder of sales generated in Canada.
Some 20,000 workers are employed by the business which operate at some 300,000 customer locations, being served by no less than 350 facilities.
The company claims to be the #2 operator in a fragmented $48 billion industry, holding a mere 6% market share in this industrial service offering industry. With many businesses outsourcing many of such services, Vestis aims to grow the business by 5-7% in the coming five years, hoping to achieve EBITDA margins equal to 18-20% of sales.
The business was impacted by the pandemic given the nature of the activities. A $2.59 billion business in 2019 saw sales fall to $2.41 billion in 2021, before revenues recovered to $2.64 billion in 2022. This marks modest growth as this results in stable sales despite inflationary trends over time. Adjusted operating earnings of $266 million in 2022 were down three million from a $269 million number in 2019. Adjusted EBITDA was reported at $373 million in 2022, resulting in margins equal to 14% and change in relation to reported sales.
So far this year revenues have seen modest mid-single digit growth in the first three quarters of the year, with earnings rising as well. At this pace, revenues are seen around $2.8 billion with margins seen around 10%. Year-to-date adjusted operating profits of $197 million are up $18 million, making a $270 million number realistic likely for the year.
About The Valuation
With the company on track to generate $270 million in operating income, realistic operating income will fall to just below a quarter of a billion, as the company expects to incur $20-$25 million in costs related to being an independent publicly traded business, while the company will enter into a customary transition service agreement with Aramark as well.
With the business operating with a $1.47 billion pro forma net debt load, leverage is high. Based on a $373 million EBITDA number in 2022, leverage is seen around 4 times. While EBITDA is set to increase a bit in 2023, there is the issue of the to-be-incurred costs following the separation.
Based on a realistic $250 million operating profit number, I believe that the company might incur some $70 million interest costs (on a net debt load of $1.47 billion). This would yield pre-tax profits of $180 million, perhaps around $135 million after factoring in a 25% tax rate.
With Aramark reporting a 262 million share count for the third quarter, I believe that Vestis will operate with some 131 million shares based on the communicated exchange ratio. That would imply that the business is on track to earn about a dollar per share in earnings here, all while the business is quite leveraged.
Based on the long-term EBITDA margin target near 20%, there could be upside to those numbers, but let us first take a look at the performance post the spinoff, as guarantees are hard to find in the business of investing.
The Market’s Take
Shares of Vestis, still sometimes called Aramark Uniform & Career Apparel, LLC, have traded between $16 and $19 per share in the first day of trading, to settle at $17. This looks fair with earnings power seen around a dollar, as some leverage is apparent. Shares of Aramark fell from $34 and change to $25 overnight, which makes sense half a share of Vestis is valued at $8.50 per share after the first day of trading, implying that shares of Aramark have actually fallen about a dollar if we adjust for the spinoff.
Quite frankly, I do not see a reason to bet involved with Vestis here, although it could become an interestingly positioned business, certainly if margins improve, but for that we have to look at the post-split performance in the quarters to come.
Earlier this year I believed that Aramark itself was not making a mark, and the spinoff has not really altered this neutral take, which now goes for Vestis and its former parent company, although I am keen to keep an eye out on Vestis here, certainly if margin achievements can be delivered upon.
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