Aramark Needs To Deliver Better Growth And Improve Margins

Food, facility, and uniform services company Aramark (NYSE:ARMK) has been a laggard for some time, with the shares trailing its closest peers Compass Group (OTCPK:CMPGY) and Sodexo (OTCPK:SDXAY) over the last few years. This underperformance has come as the company has found it difficult to meet its growth targets, and there is still some skepticism as to whether management will succeed in driving meaningful expense reductions.

I do think the company can and will do better both in terms of revenue growth and margin improvements, and the mid-teens FCF growth that I model would support around 9-10% total return potential. That's a little shy of my typical return goal, and I would like a little more upside relative to the risk of ongoing underperformance relative to the likes of Compass. That said, Aramark does serve sizable markets that can support mid-single-digit revenue growth, and some of the company's early IT-driven cost-reduction efforts do seem to be working, so I can't completely dismiss the bull case.

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Aramark Needs To Deliver Better Growth And Improve Margins

Investopedia: Will QE3 Give Paychex More Than it Takes Away?

When you're in the business of processing payrolls for small employers, a weak job market is a definite limitation on growth. Paychex (Nasdaq:PAYX) has been muddling through this period of weak job creation, and now there is a new Federal Reserve stimulus program specifically targeting job growth and employment. It's an open question as to whether this stimulus will succeed, but it's a near-certainty that low rates will continue to pressure Paychex's ability to wring profits from its float. That sets up Paychex for a high-quality but growth-poor play on improved employment, and an expensive one at that.

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Investopedia: Will Stimulus Push Cintas Higher?

The United States employment situation really hasn't gotten much better over the last year, but that hasn't hurt the shares of uniform supplier Cintas (Nasdaq:CTAS) all that much. Up more than 45% over the past year, it's worth asking whether investors have already baked in an improving job market - even if those improvements have yet to show up in the government's statistical data. Cintas remains a high-quality, well-run business with some meaningful barriers to competition, but the valuation case is a little more unclear.

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Investopedia: Healthcare Services Group - Great Business ... Great Stock?

If you can reliably reduce costs for healthcare facilities, you're going to be quite popular. To that end, Healthcare Services Group (Nasdaq:HCSG) has indeed built a very appealing and scalable business in providing housekeeping, linen/laundry and dining services to healthcare facilities. While this company has a pretty compelling dividend story, the valuation is a bit confounding.

Cost Challenges Bite into First Quarter Results
Although Healthcare Services did well on the top line, cost control proved to be a more challenging situation. Revenue rose 25%, as the company continues to see solid performance in its core housekeeping/laundry services, but also impressive growth from dietary services, as more clients add these services.

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Investopedia: UniFirst Shan't Be Last

With the reports of job growth still fairly unimpressive, it would seem logical to think that the providers of uniforms to employers would be in trouble. That's the problem with making assumptions about what constitutes "logic" sometimes - in actual fact, uniform service providers like UniFirst (NYSE:UNF) are still seeing respectable growth in revenue and these shares have been fairly strong on a relative basis.

More Growth to Start the Fiscal Year  
UniFirst reported that revenue rose almost 15% for the fiscal first quarter, stimulated by 17% growth in the small Specialty Garments business and a solid 12% organic growth in the core laundry business. The first aid business was also strong (revenue up more than 22%), but it represents a trivial part of the company's total revenue. (For related reading, see A Look At Corporate Profit Margins.)

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Investopedia: Paychex Puts A Damper On Investor Enthusiasm

There are no perfect metrics for judging the economy, as even widely-watched numbers like GDP and the CPI have their flaws. That leaves a lot of room for reading the tea leaves and using companies in industries like transportation, commodities and business services as proxies for all or part of the economy. 

Payroll services company Paychex (Nasdaq:PAYX) is a case in point. Automatic Data Processing (NYSE:ADP) provides useful data about payroll trends, but this company's client base is geared more towards the larger corporations; Paychex is far more focused on the small/mid-sized business community that employs many workers in the U.S. Looking at these recent results, it is still pretty clear that the recovery in the stock market is running well ahead of the recovery in the economy. (For more, see Inside National Payment Systems.)

Earnings - Good Enough, But Not Great
There is nothing in Paychex's fiscal third quarter results that suggest the economy is in any danger of overheating. Although revenue growth of 5% was slightly better than analysts expected, core payroll services growth was just 2%. The company is seeing some success in cross-selling its other HR services, and this segment showed solid 13% growth. Float earnings continue to be lackluster - earnings from this segment fell 16% on 6% higher average balances as the company continues to muddle through the low rate environment.


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Men's Wearhouse Gets A Sharp Markdown

Men's apparel retailer Men's Wearhouse (NYSE:MW) may guarantee that its customers will like how they look, but that doesn't guarantee that shareholders will be happy. Although the company's third-quarter report held no particularly bad surprises, management guided toward a larger loss in the fourth quarter and traders swiftly cut down the price of the stock. 

A Mixed Bag for the Third Quarter 

On the top and bottom lines, there was not much to fault about the third quarter at Men's Wearhouse. Revenue jumped 19% and handily exceeded even the highest published estimate. Sales were helped by 13% growth in tuxedo rentals, 8% growth in the retail segment and over $50 million of acquired growth in the corporate apparel segment. That puts overall organic growth more in the range of 8% (and consistent with comp-store growth of 9.6% at Men's Wearhouse) - a level that compares favorably to MW's most direct comparable, JoS. A. Bank (Nasdaq:JOSB), which reported overall growth of 7% and comp-store growth of 3% for its third quarter. 

Profitability, however, was more problematic. Gross margins dropped a full point, due in large part to aggressive promotions. Consequently, a more than two-and-a-half point drop in clothing margins offset ongoing improvement in the very high-margin tuxedo rental business. Although operating expense growth of 16% was less than sales growth (so there was positive leverage), that is still a pretty rapid pace of growth - even stripping out some "one-time costs" leaves SG&A growth at 12%; a level that may still concern investors waiting to see whether this company can recapture past margin leverage.

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Cintas Not Scintillating

These are lousy times to be in the business of providing services to business. Whether you look at payroll and HR service companies like Paychex (Nasdaq:PAYX) and ADP (NYSE:ADP), staffing companies like Manpower (NYSE:MAN), or sanitation service providers like Ecolab (NYSE:ECL), the combination of stagnant employment and cost-cutting has been a headache for almost every player. As the leader provider of uniform rentals in North America, Cintas (Nasdaq:CTAS) is likewise caught up in that malaise. 

The Quarter That Was
All things considered, Cintas likely made the best of a difficult situation in the company's fiscal first quarter. Overall revenue growth exceeded 3%, with organic revenue growth of just under that figure. Although core uniform rental revenue was barely positive, at least it was positive, unlike the negative organic revenue performance in the prior quarter. On the other hand, the company did see solid double-digit growth in both uniform sales and document management.

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