Vestis Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Vestis Corporation provides a range of workplace uniforms and related services across the United States and Canada, it caters to a wide array of industries, including manufacturing, healthcare, and food processing.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview Vestis operates in the uniform and workplace supplies industry, a segment marked by steady, recurring revenue streams. They have a diverse customer base across many different industries. The company provides rental programs, including maintenance, repair, and laundry for uniforms, as well as the sale of new and used items, including apparel, safety products, floor mats, towels, and linens.

Revenue Distribution: The company operates primarily in the USA with small operations in Canada, its business is organized into two segments:

  • Uniforms and Workplace Supplies: This segment involves rental, cleaning and supply of uniforms, floor mats and other workplace products

  • Other: This is smaller segment that involves production, distribution and sales of workwear, safety and specialty products

  • United States makes up the majority of the revenue, 79% in fiscal year 2023, as well as 82% of operating income
  • Canada makes up for the rest of the revenue at 21% in fiscal year 2023, and 18% of operating income
  • Across different financial reports, revenue from the manufacturing segment has been consolidated to the Uniforms and Workplace Supplies segment.

Industry Trends: The demand for uniform and workplace supplies is influenced by a few factors:

  • Employment rates in various industries.
  • The need for safety, hygiene, and regulatory compliance (e.g., food and pharmaceutical).
  • The move towards outsourcing of such services.
  • The shift in labor regulations, particularly in developed countries
  • Longer-term agreements and predictable demand.

Competitive Landscape: The industry has a large number of competitors ranging from large national players like Cintas, Unifirst, Aramark, and G&K Services, to more regional and local companies. The sector is highly competitive, with focus on service quality, reliability, pricing and cost efficiency. Differentiation within this space is difficult because products, service offerings and business practices are highly similar. However, some of the larger players have achieved advantages through scale and reputation, which has allowed them to command bigger market share and profits.

What Makes Vestis Different?

  • Vestis is the leading provider of high-quality products, that also prioritizes ethical labor practices.
  • Vestis is also focusing on improving automation to increase efficiency, which, they state, reduces costs and improves quality.
  • Vestis’s customer service is differentiated by its focus on building long-term relationships, and their business model allows for custom solutions that meet different customer’s needs.

Financial Analysis

Here’s a look at key financial trends derived from VSTS’s reports:

  • The fiscal year of the company is between September 30th, 2021 and September 29, 2023, and as of the latest filing for the quarter ending in June, it’s 3 Q in FY 2024.

  • Revenue Growth:
  • Revenue increased by 9.1% between FY2022 and FY2023 ($2.5 billion from $2.29 billion)
  • Most of the revenue growth in FY2023 was organic.
  • For the nine months ending in June 2024, revenue increased 7.6% vs 2023, to $1.92 billion from $1.79 Billion. Growth has slowed down a bit from last year.

  • In the latest quarterly filing, they saw an impressive 11.4% increase in uniform revenue in the US from Q2 to Q3.

  • Operating Income:
    • Operating income increased to $343 million in fiscal year 2023, from $284.8 million in the previous fiscal year.
    • The company’s margin profile is similar to prior years.

  • For the nine months ending in June 2024, they saw an increase in operating income from $264.2 million to $285.9 million.

  • Profitability
    • In 2023, operating margin was 13.7% and net profit margin was 7.1%.
    • Net income for 2023 was $178 million, compared to $60 million in the previous fiscal year, but it’s important to note that previous year net income was low due to large spin-off costs.
    • For the nine months ending in June 2024, net income is $158.1 million
    • Operating margin was 14.9% for the last reported quarter ending in June.
    • Gross margin has improved with the transition of low margin customers, improvements in pricing, lower operational costs, and higher volumes.
    • The business has maintained a consistent gross margin in the mid-40’s percentage range.
  • Capital Expenditures:
    • The company is investing heavily to build new processing facilities, for instance, a new state of the art facility in Phoenix, is planned to open this year.
    • In the last 3 quarter, the company has increased their capital expenditure as they aim for growth in the business.
  • Financial Position:
  • The company had $102.6 million in cash and equivalents as of June 2024.
  • They have long term debt of $1.42 billion as of latest reporting.

Moat Assessment

  • Moat Rating: 2/5

    • Switching Costs:
      • There are some moderate switching costs in place due to contract length, and integration with a business’s operations, as well as some embedded nature of software and systems for the bigger clients, it also becomes tedious to change contracts or processes. However, these aren’t high enough to provide a substantial moat, because there are always other competitors who can offer very similar service with not that high switching costs. A small or medium client can easily change to another provider without too much cost or difficulty.
      • While there are costs to switching, the explicit cost is lower than in other situations, like an enterprise software company, and even smaller clients can change with moderate disruption.
    • Network Effect: The business is a traditional business, not a network based business. The network effects do not play a part in business operations.
    • Intangible Assets: There is some brand recognition (e.g. Vestis has made acquisitions), and some implicit value based on customer relationship. But these advantages aren’t strong enough to constitute a significant moat, especially when they operate with similar service providers with same products, making them hard to differentiate from.
    • Cost Advantages: The company does have economies of scale, and better route density with increasing acquisition which creates better profitability, but other major players like Cintas and Unifirst also have similar advantages with better margins overall. The processes are easily replicated, and no firm can claim to have unique process to get the lowest costs.
    • Their scale advantage is not big enough to create a major competitive advantage.
    • Scale Advantage: The company is larger compared to the other smaller players in the industry, but it is still one of the smaller players compared to large competitors. The company has acquired smaller players to expand the geographical presence, but their routes still have to get optimized for the full scale potential.

  • Overall Moat Summary: While Vestis does have some characteristics that improve customer stickiness and operational advantage, their structural economic moat isn’t large, or very sustainable, so rating is 2/5.

Risks to the Moat and Business Resilience:

  • Economic Slowdowns: A significant economic downturn could reduce demand for uniform and other workplace products and services, negatively impacting revenue and profitability.
  • Competition: This is a highly competitive industry. Competitors might lower prices to attract customers that directly harm the profit margins.
  • Raw Material Costs: Volatile and increases in prices of materials (like cotton and synthetics), fuel, and transportation are a constant threat. These costs cannot always be passed on to customers.
  • Labor Costs: Any increases in labor and wage costs can hurt profit margins, and it can also reduce the company’s capacity to service new clients. Also, it can lead to lack of staffing.
  • Integration Risk: The company is trying to achieve scale through acquisitions, which have an inherent risk that integration of different systems and operations might not be as smooth or as lucrative as expected.
  • Technology Change: Automation can improve efficiency and reduce costs. But as with all technology investments, there are risks like cost overruns, underperformance, or obsolescence.
  • Customer Turnover: Even though there are some contractual obligations, and some switching costs, customers might still switch to another provider for lower prices or better services.
  • Geopolitical Risks: The ongoing conflict between Russia and Ukraine is still causing disruptions in supply chains, which could also affect the cost of raw materials and operations.

  • Poor Acquisitions: There is a risk that any acquisitions made by the company might turn out to be dilutive or fail to generate expected returns.

    Business Resilience: - The business has some level of resilience due to their recurring revenue model. - They have diversified across different industries, so they can be resilient to fluctuations of single industries. - But all these measures are not enough to counter very severe business or economic shocks, which is why a wide moat is important to sustain operations even during difficult times.

Understandability Rating: 3/5

  • The business model is relatively easy to grasp, as it involves a straightforward service offering with uniforms and workplace supplies. However, there is a moderate level of complexity with the financial statements.
  • Analyzing the financials requires a careful understanding of a few metrics. And although most numbers and drivers of revenue are clear, calculating the valuation requires more analysis of their debt and their cost of capital.

Balance Sheet Health Rating: 3 / 5

  • The company is carrying substantial amounts of long term debt, close to 5.7 times their equity.
  • The company is reporting higher operating income and profits than before due to increase in sales and efficiencies in business.
  • The debt is mostly fixed rate, so that is not very sensitive to interest rate changes. But their ability to generate enough cash flow and profit to cover the large amounts of debt is still questionable, as it depends on the operational performance which is never certain.
  • While their business has been showing great profits, the high debt and liabilities are a concern, and is why they can’t get a high health rating.

Recent Concerns and Management’s Stance

  • Global Supply Chain: The company management has noted an impact of inflation in their Q3 financial reporting. They have also talked about the global supply chain instability which has affected their supply and inventory. They believe that the cost pressures will remain in the near term, which might affect their revenue and margins
  • Guidance: For the full fiscal year 2024, VSTS is guiding 5% organic revenue growth, and 35 to 50 basis points margin expansion. They are also committed to bringing down their leverage to 3.0 to 3.5 times Ebitda in the next few years.
  • Employee Costs: Management has acknowledged that they see increasing employee costs, and have implemented several initiatives to reduce those costs. But they believe that they can offset these increased costs through new technological implementation.

While the management seems positive for the future, it is to be seen how those targets are achieved, and if they are able to create long term shareholder value.