Description

Vestis (VSTS Equity) is a provider of uniform rentals and workplace supplies in the US and Canada. Formerly known as Aramark Uniform Services, Vestis was spun out of Aramark on October 2. The spin has been messy, with Vestis trading down from $20/share to a low of $14/share as Aramark shareholders sold their non-core Vestis shares.

We believe the stock has a +30% IRR from $17/share today. Our target price is $39/share at YE 2025, assuming a 13x EBITDA multiple on $500mm of 2026E EBITDA.

Thesis

Vestis’ operational improvements efforts should close the growth and margin gap with peers

• We are excited for the new BoD and the expertise it can bring. It is chaired by the former COO of Cintas and includes the former CFO of competitor G&K. We also have mostly favorable views of the CEO so far and the rest of the management team has been refreshed in the last 1-2 years, which we believe was necessary.
• Vestis has overhauled its dated internal systems and expanded its previously undersized salesforce over the last 3-4 years. We believe the Company should see continued benefits from these efforts in terms of new business wins, increased retention, and better cost efficiency through inventory management & routing.
• There is a sizable growth & margin opportunity related to increasing cross-sell at existing clients and better leveraging fixed costs through driving new business. We think the Company is now better position to take advantage of these opportunities.
• Historically, Vestis has been a share loser and did not participate in the MSD market growth that benefited its competitors. With recent improvements, we believe it will be able to now grow with the market.
• We do not expect Vestis will catch up to Cintas (the best in class operator – trades at 23x EBITDA) but we believe it can improve from its position today and widen the gap to UniFirst (10x EBITDA).

An acquisition by Cintas or UniFirst is possible

• Acquisitions in the uniform rental space are very accretive; acquirers in recent M&A have projected a doubling of EBITDA through synergies. This is a result of improving route density, leveraging plant capacity, and knocking out duplicate functions.
• Cintas has had great success with M&A and is running up against capacity constraints, which has inspired acquisitions in the past. An acquisition by UniFirst would also be very accretive.
• Vestis is likely one of the few, if only, willing seller of size in the industry.

The Company

In FY23, we expect Vestis to produce $2.8B of revenue and $375MM of PF EBITDA (13.4% margin).

The Company’s revenue is split between uniform rentals (36%), towels & aprons (22%), linens (11%), floor care & mats (15%), restroom supplies (6%), and first aid (2%). It also sells uniforms directly to customers who do not rent (8%).

VSTS services 3,400 pickup/drop-off routes with 20,000 employees across 350 facilities including laundry plants (~35% of total plants), satellite distribution facilities (~65%) and 2 manufacturing facilities in Mexico. VSTS produces about 50% of the uniforms in-house and some portion of the mats, and buys the rest of supplies from 3^rd parties.

The company serves customers on 3-5 year contracts. Route drivers generally visit its customers weekly and provide newly washed uniforms, linens, towels, and/or mats while picking up used items which will then be washed and returned the next week. During this visit, the driver also drops off other consumable supplies.

Source: Company filings

The Spin-Off

In May ’22, Aramark management announced that the Company was planning to spin off the Uniform Services division in FH2 ’23. The spin was completed on October 2. At that time, each shareholder of Aramark received 1 shares in the SpinCo for every 2 shares owned of Aramark.

In connection with the spin, the Company issued $1.5B of term loans and the proceeds were transferred to RemainCo to pay down debt. An undrawn $300MM revolver was also put in place. The SpinCo is be levered 4.2x net, with a FY26 leverage target of 1.5x-2.5x. The RemainCo is levered 4.6x net post-spin, compared to leverage ex-spin of 4.4x. RemainCo should de-lever to under 4.0x by YE24 as results rebound.

Generally, this spin makes good businesses sense and we historically expected that the Uniform business could be separated at some point (as did many other investors). We believe this for the following reasons:

An outright sale of the business was not feasible due to its low tax basis

• The potential tax bill related to a sale would’ve been too large pre-spin, given Vestis’ low tax basis while a part of Aramark. This basis will step up post-spin for any acquirer that did not indicate interest in the last 2 years.

VSTS should benefit from operating as a standalone business.

• Now that it is operating on its own, VSTS will command the full focus of management, who will be able to properly invest time and resources in improving it.
• VSTS previously accounted for just <15% of ARMK’s sales and <25% of EBITDA. Thus, it was a bit of an orphan business at ARMK and management spent most of its time concentrated on the Food Service business.

Value unlock; uniform should trade at a premium

• Aramark has historically traded on a Food Service multiple, which tends to be lower than a uniform rental multiple. We believe investors have not given proper credit to uniform when valuing the company.
• We believe standalone Aramark should trade at a ~10x EBITDA multiple while our Base Case assumes Vestis should trade at a 13x multiple.

Limited dis-synergies

• The only cost dis-synergies related to separating the businesses relate to corporate overhead and standalone costs.
  • ARMK Mar ’23 earnings call: “Frankly, [Vestis has] been operated independently from a management perspective forever. It's never really been operated on an integrated basis”
• Customer overlap is limited and the relationship with those customers shall remain unchanged.
• Aramark Food Service is a large customer but this relationship has always been carried out at arms-length, shouldn’t materially change, and will be governed by an MSA.

A Note on Investor Day Targets

Vestis held an investor day on Sept. 13^th and introduced financial targets for the new business. These targets included the following through FY28:

• Annual organic revenue growth of 5-7%. The includes 2-3% growth through new business, 2-3% growth through penetration at existing customers, and 1% price growth.
• EBITDA margin expansion of 400-600bps. This includes 200-300bps of operating leverage and 200-300bps of efficiencies and cost cuts.

These targets are very optimistic. Organic growth expectations are in-line with Cintas’ historical performance and half of the margin target relies on hitting this growth outlook. We think the Company will likely underperform these targets and view them as our Bull Case. However, we do not think that the post-spin valuation will reflect these targets and therefore this should still be an attractive investment even if they underperform management’s expectations.

Market Overview

The Uniform Rental & Adjacencies industry has a TAM of $48B according Vestis.

We have evaluated the company’s TAM estimation and the implied conversion opportunity left. We believe it is reasonable to conservative. We’d split the market as follows:

• Uniforms: $10B. We conservatively assume this is 100% penetrated and TAM = industry revenue. In reality there is likely some conversion opportunity left but it’s small.
• Linen: $8B. Same as above, we conservatively assume TAM = industry revenue.
• Adjacencies: $30B. There are 9mm business locations in US and Canada and the average customer spends $3000-4000 annually on adjacencies. This is conservative as we expect penetration of adjacencies at customers should increase over time.

Market share is split as follows:

• The largest 3 players hold ~30% market share combined (Cintas 18.4%, Vestis 5.8%, UniFirst 4.5%).
• There is a tail of private players that account for another ~30% of the market.
  • Private players include Alsco with >$1B of US revenue, ~15 players that have $100-500MM in revenue, and ~400 smaller players with $5-100MM in revenue (avg. $20-40MM). Private players tend to be more focused on linen and tend not have as fulsome an offering of adjacencies.
• The remainder of the TAM (40%) is made up of potential customers referred to as non-programmers. For example: a small biz that buys a first aid kit on Amazon and manually refills it when certain components run out.

     Source: Company filings, Baird Estimates

• The tail of small players has shrunk over time. This has partly been due to acquisitions and partly because Cintas has consistently taken share. UniFirst also consistently took share up until about 10 years ago when gains slowed. Vestis has seen share flat to slightly down.

                                                Source: Baird Estimates

Market Growth

Market growth has historically been 4-5% per year, with uniform rental and linen growing slower than average while ancillary products grow faster. Price generally accounts for 1-2% of annual growth while the remainder is volume. We expect market growth will likely slow to ~4% over the next 5-10 years due to slowing employment growth.

• Uniform Rental: Historically grown ~3% annually. Volume is driven by employment growth both overall (+1.2% annually over L10Y) and particularly at manufacturers (+0.7% L10Y) due to the industry’s outsized exposure to that sector. A small amount of non-programmer conversion also drives growth (mostly done by CTAS). Going forward, employment growth is set to slow overall (+0.3% N10Y) and in manufacturing (-0.1% N10Y).
• Adjacencies: Historically grown at 6%+ per year. Core growth drivers include employment growth and business location growth (+1% L10Y), but volumes outperform these drivers because of continued penetration at existing customers and conversion of non-programmers.
• Linen: According to experts we’ve spoken to this space grows about 3% annually. This is driven by the proliferation of non-hospital medical facilities, an increase in hotel rooms over time, and flat to down usage of linen in restaurants. This space is ~fully penetrated so conversion of non-programmers does not factor in much.

In recent years there has been fluctuation around the long term average with volumes flat to down and price growth limited in 2020. There has since been a rebound in both volume and price (to cover inflation). In recent quarters growth rates have started to moderate but are still above pre-pandemic averages.

Source: Company filings

Major Industry Participants

Cintas is the best operator with the best service and the best products. They have a very process-oriented and efficient business full of relatively high quality people. Customers are very positive about their relative service levels and the quality of their products (plus they have licensing agreements with popular brands like Carhartt).

• They have been able to drive above market revenue growth (6-7% organic) and have consistently improved margins. EBITDA margins have risen by 750bps since 2013 and sit at 25% vs. 13-14% at UNF and VSTS. About 2/3 of this expansion has come since their acquisition of G&K in 2018.
• Revenue growth is enabled by higher than average retention (>95%), a high win rate due to their service levels, and an impressive ability to convert non-programmers (60% of new business wins).
• Margin performance is driven by a number of factors, which also contribute to revenue growth: (1) customers are willing to pay a premium for Cintas’ higher quality offering, (2) they have superior route density, fixed cost leverage, and sourcing capabilities because of their scale, (3) they are strong everyday operators, have the best technology and have the most vertical integration, (4) they have been very successful with M&A, most notably their acquisition of G&K in 2017 which was highly successful in terms of synergy realization.

UniFirst is a step below Cintas. It’s service levels are middling, its products are average quality, and it competes much more on price than Cintas does (like most of the industry). It tends to be more focused on Uniform Rental as well (55% of sales vs. 35-40% at competitors).

• UNF has consistently posted solid revenue growth at 4-5% despite its high uniform exposure and a poor job of penetrating existing customers (sales growth is 90% new business wins and 10% penetration).
• EBITDA margins have shrunk ~575bps since 2013 and 3/4 of this has come since 2019. Margins are now ~13%. UNF has done a poor job controlling costs, and has been willing to give up margin to drive growth by being aggressive on price.
• Capex is also higher than comps at 6-8% of sales vs. 3-4% at competitors. This is due to lack of relative scale, poor cost discipline, and the need for capacity expansion to meet demand.
• Overall, the company is poorly managed. This is a family business: >70% of voting power is in the hands of the Croatti family, the CEO position was filled by a Croatti from 1936-2017, and there are currently 5+ Croattis at all levels of the Company from sales rep to the Board. The family did a great job building the business but in recent years there appears to be little focus on shareholder value.

Vestis is also a step below Cintas. Its service levels have historically been equal to or below UniFirst, its products are average quality, and it competes mostly on price like others in the industry. It is somewhat disadvantaged cost-wise by its large union presence (50% of employees vs. <5% at competitors) and tends to focus on price-sensitive national accounts more than comps.

• Revenue growth has lagged competitors at 1-2% annually over time, mostly driven by price.
• EBITDA margins have been flat since 2013 when adjusting for an accounting change in FY19. There was small expansion prior to COVID (~75bps), but this then reversed as the Company was impacted by operating leverage on negative volumes and cost inflation, while investments in the salesforce and CRM system investments also weighed on margins. Only in the last 2 quarters did VSTS return to levels near or above pre-COVID levels.
• In general, we believe this business has been underinvested in and poorly managed. (1) Company culture was generally describe as poor by formers, (2) decision making was left in the hands of regional managers who did not always make the right decisions, (3) route drivers tended to be of lower quality than competitors, (4) internal systems were very dated up until recently, (5) the salesforce was undersized until recent hires were made.

Source: Company filings

1. Vestis has recently undertaken numerous operational improvements that should drive growth and margins higher.

Refreshed management team and new board should drive improved outcomes

• We believe that the new management team and board have the right experience and our checks have come back mostly positive.
• CEO Kim Scott was hired in October 2021. We have spoken to individuals in the industry who have given positive feedback on her competence and management style.
• Kim has also refreshed the management team, hiring a CFO in May ’22, a COO in Sept. 23, and a CTO in Jan ’23. We believe that a changeover was necessary.
• The board that Vestis has put together is also very exciting. The Chairman will be Phillip Holloman, who spent 22 years at Cintas, 16 of which he was COO. The board also includes the former CFO of G&K, who helped oversee the transformation of that business before selling to Cintas. 3 of the remaining 5 non-executive members hold or held CEO/CFO positions at route based businesses including Brinks, ADS, and Waste Connections.

Internal systems/technology investment should drive continued incremental improvements

• Vestis historically used dated and piecemeal internal systems that were a hinderance to sales force productivity, new business wins / client retention, merchandise control, and efficient routing.
• Vestis recently rolled out a new internal system that includes CRM, routing, and inventory management capabilities. It was deployed at its first locations in late 2019 and finished deployment in the fall of 2022. The system they use is industry standard and already in place at many regional competitors. UniFirst just finished rolling out a system from the same provider.
• It’s been about a year since full deployment and we believe there is a long runway for deriving financial benefits from this new system. The business is complex (high number of facilities, routes, and customers) so it takes time for best practices to be rolled out, and many of the advantages are subtle and work in conjunction with other initiatives. As a result, this will continue to benefit the business over time incrementally.
  • CTAS finished its CRM/ERP deployment in May ’20 and as recently as their March ’23 earnings call they said: “we're very much in the early innings of [our new CRM]… we went through all the implementation, there's always work to be done there.”
  • CTAS CFO from their Jul ’19 earnings call: “There is a learning curve… this is a system that is heavily data-dependent, and we have to change our business processes locally to be able to use that system most efficiently
• There are numerous specific benefits that can be derived from this new internal system
  • More efficient sales force and better customer experience
    • The prior system made it difficult to leverage customer information to cross sell and target price increases. Now there is a much more usable customer database which is an essential tool to drive salesforce productivity.
    • Salespeople and drivers can now have customers sign contracts digitally and the new process will reduce paperwork and cut customer onboarding time from 8+ weeks to 4 weeks.”
    • They have also launched a new customer portal that will allow customers to easily manage their account online. While this sounds like table stakes, Cintas launched a similar portal about a year ago and lauded it as “unique”, “an advantage in the marketplace”, and said its impact is “showing up in customer satisfaction and customer loyalty”.
  • Improved routing
    • The routing system was previously static and required a lot of manual oversight by plant managers to make sure every customer was being serviced correctly. The new system enables more dynamic routing and frees up time for plant managers to focus on other tasks.
    • In conjunction with this investment, the Company is working with a logistics consulting firm to optimize its routing to be more efficient. They historically have had issues with drivers driving past one another to serve customers or even had customers served by multiple drivers.
    • Management sees this as a $30-50MM annual benefit to be realized through FY28

• • Improved merchandise tracking
    • Merchandise tracking was previously very manual and re-use of garments was not emphasized to the extent it should have been. This led to uniforms being stolen, lost, or being thrown out before the end of their useful lives. Given that merchandise accounts for ~1/3 of total COGS, better inventory control can have a large impact on profitability.
      • Increasing the usage of used garments as a % of total garments by 1pp would result in a $1.4MM bump in profitability. Garment re-use is currently very low according to management. In a case study, they said they improved this measure by 11pp at one of their facilities without making any material monetary investment.
      • A former Vestis VP of Ops cited merch control as one of the two most important influences on profitability (the other being customer retention).
      • CTAS CFO from their Sept ’21 earnings call: “We get some real nice incremental margins when we can more efficiently use those or put back those garments into service. [Our new system] has allowed us… to improve the use of those garments within our stockroom.
    • Poor merch control also degrades customer service; poor tracking meant drivers were more likely to show up with the wrong number of uniforms.
  • There is other evidence that there should be material economic impacts of the leveraging of the new system.
    • At the beginning of the system rollout in the ’20-’21 timeframe, management talked about the new system contributing ~200bps of margin improvement.
    • CTAS EBITDA margins have expanded ~250bps since it rolled out its new system in Q4’ 20. Some of this was undoubtedly a result of G&K synergies, operating leverage, and strong execution, but this is broadly a positive sign.

Investments in the salesforce and new selling practices should drive improved growth and margin expansion relative to history.

• VSTS’ salesforce has historically trailed behind competitors in size, which has held back growth.
  • The Company finally recognized this issue and began to hire more salespeople in 2019. They began with est. 1000 salespeople, adding ~150 by Sept ’20 and ~350 total by mid to late ’21.
  • Vestis is also implicitly adding to the size of its salesforce with its new strategy of putting route drivers in charge of cross selling existing customers, freeing up salespeople to focus on new account growth.
  • The salesforce is now benefitting from improved support and tools through the new internal systems, which should improve efficiency and effectiveness.
  • The Company is now focused on selling to 8 sub-verticals which they believe will be the most profitable. They are all >$300MM in size and have the following characteristics: >$300 in stop per customer, higher than average penetration opportunity, <1% of customers spend or a regulatory obligation exists. The one example of a subvertical they gave was car dealerships.

These improvements have tangible benefits related to leveraging fixed costs and cross-selling

• Incremental margins
  • Vestis’ long term guidance implies incremental margins in the low-to-mid 20s (excl. cost saves). We think this is reasonable considering that Cintas incremental margins have historically been about 30%, but Cintas has a more efficient cost structure.
• Cross-sell opportunity
  • Over 40% of CTAS comparable (i.e. ex-fire) revenue is made up of mats & floorcare, first aid, and restroom services and it still touts its ability to drive further cross-sell. These products only make up 23% of VSTS revenue, indicating an even greater opportunity to drive cross sell.
  • Our estimates below show that there is a cross-sell opportunity equal to $2B revenue and $1.25B contribution margin. The Company itself estimates a $4B revenue cross sell opportunity.
    • We do not include towels, linen, and uniforms as we think these are more likely to be “core” products for customer and are less likely to be cross-sold. Any opportunities in those spaces would be upside to our estimates.
    • According to our contacts in the space, adjacent products are significantly higher margin than “core” products like uniforms (15-25% incremental margins) and linens (10-15%).

G&K Services provides a case study: this type of overhaul has been successful before.

• G&K was the 4^th largest player in the industry up until its acquisition by Cintas in 2017.
• From FY00 to the cyclical peak in FY09, G&K grew EBITDA just 2% per year; on an organic basis we estimate EBITDA fell mid to high single digits annually. EBITDA margins fell from 20.5% to 11.6%.
• A new CEO was hired in 2009 and was able to drastically improve the business. G&K focused on re-doubling customer service and operational excellence. This included improving merchandise control, routing, plant operations, and sales force productivity, while introducing new tech into the business to assist with this. They walked away from unprofitable customers as well. As a result, EBITDA growth picked up without any net acquisitions, as you can see below.
• G&K was eventually sold to Cintas for 12x NTM EBITDA at a time when uniform rental multiples were much lower (Cintas was 12x EBITDA vs. 22x today).
• We believe that VSTS can use a lot of the playbook G&K used to improve the business, and the formers of CTAS and G&K on the BoD should provide support for this.

Management has loosely guided that ’24 margins should only rise slightly Y/Y, but we think the Company could outperform.

• Management expects there to be margin expansion every year through ’28, but they noted that next year should see a drag from public company costs (guided to $20-25MM) and separation costs, therefore the expansion will be “muted”.
• However, we believe that a number of tailwinds should help drive margins to outperform management’s rough guidance. The factors we list below combined to account for a ~140bps positive impact on their own, vs. an ~80bps projected impact from public company costs. This does not include incremental help from operational improvements or operating leverage.
• Excess merchandise amort will roll off over the next year
  • When the Company puts new merchandise in service, it amortizes the cost over 18 (uniforms) to 24 (mats) months. However, uniforms have a true useful life of 24+ months and mats 36+ months. Thus, when you add a large amount of merchandise in service, the amount of inventory amort increases to a higher proportion of revenue than normal until that inventory is fully amortized.
  • Vestis added a significant amount of merchandise in service in FY21 and FY22 as demand rebounded and commodity prices increased the cost of merch. Thus, excess merchandise amort has weighed on margins. However, falling commodity prices and a moderation of the post-COVID rebound has led merch in service to flatten out, thus the merch amort headwind should roll off over the next few quarters.
  • We expect this to lead to 60bps of Y/Y margin expansion in ’24.

Source: Company filings, Bloomberg

• Contracts with price/cost challenges are being restruck
  • Vestis reportedly has a substantial exposure to national accounts (30%+ of sales). These accounts are likely to have strict mechanisms in their contracts that limit the amount of price that can be passed through (unlike smaller accounts that have much more flexible language).
  • Given that inflation has run higher than pre-2021 contracts would’ve contemplated, we believe that there are a number of pre-2021 national account contracts that are still price/cost challenged. As these contracts (3-5 year average term) are restruck over the next 2-3 years, margins should improve somewhere between 20-60bps.

• The Company has instituted $28MM of cost cuts
  • They were launched during Q3 and are all in place as of now. These related to headcount and streamlining the organization. We began to see the impact of these in FQ3 margins (+130bps Q/Q, though there were other impacts baked in).
  • This should result in ~35bps of Y/Y margin expansion for FY23 and an incremental ~65bps in FY24.
• Falling labor costs could drive disinflation despite union contracts. This is a longer term impact (may not affect ’24 significantly).
  • Labor accounts for 50% of costs and 50% of labor is unionized (70% of frontline workers) across 200+ CBAs. Management says they have expect 5% labor inflation over the next few years.
  • This projection appears reasonable given that wage inflation will be lagged a bit due to the timing around CBA negotiations. However, we think it’s possible that wage inflation could undershoot if current trends persist. As you can see, growth in average hourly earnings for Uniform & Linen supply workers has turned negative in recent months after peaking at 10%+ through the pandemic period.

                                          Source: BLS

2. Vestis could be an acquisition target

An acquisition of Vestis by Cintas or UniFirst would follow good industrial and financial logic

• Acquisitions within the uniform rental space can be very accretive
  • The buyer is able to increase route density, increase purchasing scale, and better leverage plant capacity while knocking out duplicate overhead and locations.
  • The 3 largest players have made over $5B of acquisitions in the last 10 years. This includes the $2B G&K acquisition by Cintas in Mar ‘17 and the $1B AmeriPride acquisition by Vestis in Jan ’18. Most of the other acquisitions are of much smaller mom and pops for <$10MM.
  • Cintas’ acquisition of G&K was a home run partly due to the high level of geographic overlap. It also provided much needed plant capacity to Cintas, which was running up against full utilization in many locations. We believe it surpassed synergy targets that implied a doubling of G&K EBITDA.
• The acquisition of Vestis by Cintas or UniFirst in particular has merit
  • Vestis, UniFirst and Cintas all cover ~all of the major MSAs in the US. The geographic overlap creates a huge opportunity for an acquirer (i.e. UniFirst or Cintas) to build route density and shut duplicate offices.
  • Cintas is running up against capacity constraints again (CTAS CFO said on their FQ4 ’23 earnings call: “we have capacity needs in certain places”). Meanwhile, Vestis has a large amount of unused capacity at its plants. An acquisition could help Cintas avoid the time and cost of building new plants and drive synergies from better leveraging Vestis’ capacity.
  • Vestis’ large union presence (50% of employees vs. <5% at comps) could deter Cintas from buying them, given that Cintas is opposed to operating with unionized employees. That said, Cintas has historically had success in driving out the unions at companies it acquires, which it could do at Vestis.
  • There are few large acquisition targets left outside of Vestis. Cintas could buy UniFirst but we do not believe the family would be willing to give up control. Alsco is the only other competitor of similar size but has large overseas operations and a linen focus, making it less unattractive. There are also a limited number of competitors that have anywhere near $500MM in sales and many of these are either linen focused or have reportedly already rebuffed approaches.
• An acquisition could face anti-trust concerns, but an analysis of the HHI index indicates Vestis M&A could still be approved, particularly with UniFirst.
  • The DOJ considers an industry with an HHI Index of <1500 to be “unconcentrated”, and industry with 1500-2500 to be “moderately concentrated”, and an industry with >2500 to be “highly concentrated”. Mergers that increase the HHI by 100+ points in moderately or highly concentrated markets of concern from an anti-trust point of view.
  • The uniform rental industry currently has an HHI Index of ~1150 by our estimates, without taking into account the non-programmer part of the market.
  • An acquisition of Vestis by UniFirst would increase the HHI by 150 and wouldn’t warrant DOJ intervention by this metric since the industry would remain “unconcentrated”.
  • An acquisition of Vestis by Cintas would increase HHI by 600 points to 1750 and move the industry into the “moderately concentrated” bucket. It is unclear whether this would trigger the DOJ’s intervention per these heuristics, since the industry was previously “unconcentrated”.
    • If the DOJ considers non-programmers to be part of the overall market, the HHI would remain in the “unconcentrated” bucket (HHI of 620 post-merger).
  • If there are anti-trust concerns, regional divestitures could be used to remedy them.

The business improvements undertaken by Vestis may not have the financial impact that we anticipate

• This is a business that has been full of operational issues for many years. The recent improvements may not be enough to fix the business, or may take more time than expected. Improvement depends on management and personnel executing on initiatives laid out, which is not assured.
  • Mitigant: The new BoD is high quality, reviews of the CEO have been good, and large investments have been made to integral parts of the business.
• Early outcomes have been underwhelming, particularly in terms of revenue growth. If they are not able to drive incremental business wins and penetration from here, Vestis could see growth trail off back to pre-COVID levels.
  • When we compare today to FY19, revenue has grown 1.6% annually. We believe this implies that volumes are still below pre-COVID levels. Part of this is due to intentional culling of low margin uniform customers but it is not clear how much of an impact that accounts for.
  • Revenue growth has been decelerating, and in the most recent quarter Y/Y growth (4.7%) fell below management’s long term sales growth target of 5-7% (though it suffered from an 80bps headwind due to energy surcharges in the prior year that have rolled off). Growth also generally continues to lag peers.
  • The average new salesperson should’ve reached full productivity in late ‘20 and the last addition should’ve reached full productivity by early ’22. The new CRM system was fully rolled out in Fall ’22. So these measures should already be having a material impact on growth rates.

• Vestis’ plan to transition route drivers to the primary contact for existing clients could be risky. Drivers are already the “face” of the business for clients, but transactions have historically been executed by salespeople. Drivers were not hired to be salespeople and may not have interest in or be skilled at the sales aspect of the job
  • Mitigant: They are executing this transition over a 5 year period, so there will be plenty of time to adjust and ensure this strategy works and makes sense.

Weakness in employment levels and the macro environment could negatively impact results

• 36% of revenue is related to uniform rental and revenue is tied to the number of employees they outfit. Thus, a decrease in employment levels would drive a decrease in revenue.
  • Mitigant: 60% of sales are related to goods like first aid and mats that do not depend on employment levels within a customer’s business.
• Overall macro weakness can also impact the business as business closures lead to customer losses and when customers tighten budgets they may cut out services that tend to be more expensive like restroom supply.
  • Mitigant: Cintas saw only moderate weakness during the GFC while UniFirst was able to grow EBITDA.

Leverage is high at 4.2x, which could depress valuation and result in more volatile trading.

• Mitigant: We expect the Company to de-lever over time as a result of both cash generation and EBITDA growth. Leverage should decline to <3.0x by FY25 (see below).
• Mitigant: The recurring nature of Vestis’ revenue enables the business to bear a larger amount of debt than it could otherwise.

At $17/share, VSTS trades at 9x EBITDA on street estimates of $415MM of ’24 EBITDA.

• Cintas trades at 22x EBITDA. Cintas has a proven track record of exceptional performance and we do not view this multiple as achievable.
• UniFirst trades at 10x EBITDA. It is poorly run, family controlled, and posted unimpressive financial results in recent years. Vestis should trade at a premium to UniFirst.
  • The size of the premium depends on Vestis’ performance. In our Base Case we assume a 13x multiple but we believe there could be upside to that if the Company executes.
• G&K was acquired by Cintas for 12x EBITDA. It had previously traded in the 8x-11x range.

Disclaimer: The author of this memorandum presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation.  This memorandum is as of the date posted, is not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

Catalyst

Earnings, margin progression, spin-related selling pressure subsides.