Cintas (CTAS) has proven to be an extremely durable business with roots dating back nearly 90 years, and the company has rewarded its shareholders with higher dividend payments for more than 30 years.
Cintas is one of the most consistent sales and earnings growers around, and it operates in a very slow-changing industry where it maintains leading market share.
Let’s take a closer look at Cintas to see if this dividend aristocrat has a bright long-term outlook and a reasonable price for dividend growth investors today.
Business Overview
Although it was officially founded in 1968, Cintas started out as a laundry service for businesses during the Great Depression and has grown to become the largest provider of uniform programs in North America.
The company’s core business provides workers with rental uniforms that they wear each day. Cintas provides uniform delivery and pickup services via its local delivery routes, cleaning the uniforms before they are returned to workers each week.
As the company has grown, it has added facility services, first aid and safety services, entrance mats, restroom supplies, fire protection, and more to its offerings.
Today, Cintas serves over one million businesses and clothes more than five million workers every day in North America.
Approximately 70% of its customers are in the service-providing sector of the economy, and the remaining 30% are in goods-producing industries such as oil, gas, coal, construction, and manufacturing.
Segments
Uniform Rental and Facility Services (79% of 2017 sales): provides rental and servicing of uniforms and other garments including flame resistant clothing, mats, mops, shop towels, restroom supplies, and other ancillary items. In addition to these rental items, restroom cleaning services and supplies, carpet, and tile cleaning services are also provided.
First Aid and Safety Services (10% of sales): provides sale and servicing of first aid and safety products and training.
All Other (11% of sales): provides fire protection services and direct uniform sales.
Business Analysis
In some ways, Cintas’s business is comparable to a garbage collection company. The business provides each worker with enough uniforms for two weeks. One clean set is for his current workweek, while the other is being laundered and repaired by Cintas.
Cintas will send a rep to the customer’s facility to pick up worn garments and drop off each worker’s clean uniforms for the next week.
Source: Cintas
It doesn’t take a genius to do laundry, so this commodity business is all about efficiency and being the low-cost provider in a particular area (friendly service reps help, too).
With weekly stops made at every customer, route density is the best way to achieve lower costs than competitors because the cost of transportation (i.e. truck trips) can be spread across numerous customers.
To accomplish this, Cintas is the largest company in its industry with over 525 distribution facilities and more than 11,000 local delivery routes. Some customers prefer or need to do business with larger players that have more of a nationwide reach, and being closer to customers also results in better service because delivery times are shorter.
Smaller competitors will have minuscule margins if they try to compete in one of Cintas’s established areas because their transportation and operating costs are higher.
They would also have to disrupt long-standing relationships that Cintas’s reps have with each customer, although that seems like a smaller competitive advantage.
On the other hand, Cintas has the luxury of acquiring these companies to gain new geographies and increase its network density in existing regions, realizing meaningful cost synergies from its acquired businesses.
For example, the company acquired ZEE Medical Inc. for $130 million in the first quarter of 2016. This company was about one-third the size of Cintas’s First Aid business and expanded its product portfolio and ability to reach more customers across North America.
During the third quarter of fiscal year 2017, Cintas closed its $2.2 billion acquisition of rival G&K Services, with expected annual synergies of $130 million to $140 million in the year following the acquisition. The G&K acquisition added 170,000 new customers, further extending Cintas’s services capability and geographic density.
Once Cintas has a local area locked down for business, it can work on increasing its amount of sales with each customer by offering new products and services such as restroom supplies and tile cleaning.
This strategy is similar to another dividend aristocrat’s approach – Ecolab’s “Circle the Customer” business model. By offering a wider range of products and services to its customers, Cintas can increase the productivity of its reps, lower its customers’ costs, and create stickier customer relationships.
Furthermore, many of the industries in need of rental uniforms experience high employee turnover, which drums up even more business for companies like Cintas.
Cintas is also making a substantial investment in a new SAP-driven system that will enable cost savings and better cross-selling capabilities once fully implemented. This project is contributing to the significant capital expenditures Cintas is incurring ($30 million to $35 million in fiscal 2017 and an estimated $45 million-$50 million in fiscal 2018) but should further enhance the firm’s competitive advantages going forward.
While it is very competitive and sensitive to price, the rental uniform market also has a very slow pace of change and provides an essential service – it’s hard to imagine many businesses vertically integrating to start doing their employees’ laundry in-house anytime soon.
These factors have created a relatively stable competitive environment that has helped Cintas gradually grow in size over the decades. The company commanded 25% market share of the $16 billion North American uniform rentals market prior to acquiring G&K, which brings the combined company’s market share above 30%.
However, Cintas has plenty of room for growth as there are still more than 15 million businesses that don’t do business with the company currently. Other than opportunities to expand its market share, the company also has a huge potential to grow revenue and profit by penetrating its existing customer base.
The company’s diversification is another strength as no customer accounts for over 1% of its total sales and no end market is greater than 10% of revenue.
Overall, Cintas is a very durable business that has taken steps in recent years to further strengthen its moat by adding route density, expanding its service line, and taking out costs.
Key Risks
Cintas appears to have a lower fundamental risk profile than many other companies. However, its results can be impacted by employment trends, fuel, and energy costs, and the health of its end markets (e.g. the low price of oil was hurting demand from its oil & gas customers as they reduced their headcount).
Fortunately, none of these issues seem likely to impair Cintas’s long-term earnings power. If anything, they could be buying opportunities for patient dividend growth investors.
The longer term issues that could hurt the company’s earnings growth are continued outsourcing of U.S. manufacturing jobs, the rise of automation, and potential changes in the ways businesses choose to dress their employees.
With the U.S. labor market tightening, labor costs may increase in the near future. This might make domestic manufacturers less competitive than overseas competitors, resulting in factory closures and companies choosing to offshore or outsource their operations.
Rather than outsourcing, especially given the Trump administration’s stance, companies are likely to increasingly turn to automation to save on labor costs. In fact, one report believes robots will replace 6% of U.S. jobs by 2021.
Since robots don’t require uniforms, demand could be adversely affected in some of Cintas’s core industries if automation advancements accelerate over the coming years.
Not unlike consumers, businesses could also begin to develop a change in taste for their work environments and try to increase employee morale by moving away from uniforms altogether.
However, Cintas’s strong industry diversification, expanding lineup of products and services, and continued opportunities for acquisitions largely mitigate these concerns for now.
Cintas’s Dividend Safety
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
Cintas’s dividend appears to be extremely safe with a Safety Score of 99. It scores highly because of its low payout ratios, recession-resistant business, consistent free cash flow generation, and healthy balance sheet.
Cintas’s earnings and free cash flow payout ratios over the last 12 months are 30% and 28%, respectively. As seen below, Cintas’s earnings payout ratio has remained between 20% and 30% most years, which provides plenty of safety and room for continued dividend growth.
During the last recession, Cintas’s sales fell by 4% in fiscal year 2009 and 6% in fiscal year 2010. However, the company’s free cash flow per share actually grew in each of those years, highlighting the defensiveness of Cintas’s business model.
While many businesses lay off some employees during economic downturns, their remaining employees still need their uniforms laundered. Cintas has since grown in excess of U.S. GDP and jobs growth each year since the Great Recession.
Cintas has also done an excellent job generating and growing free cash flow over the last decade. The best business models generate real cash each year that can be used for growth (acquisitions in the case of Cintas) and rewarding shareholders with higher dividends.
You can also see that Cintas has created value for shareholders by earning a healthy return on invested capital over the last decade. Earning a double-digit return is very good for such a simple business and highlights the company’s competitive advantages.
Turning to the balance sheet, Cintas has a lot of debt from its recent acquisitions but still maintains adequate liquidity. The company has about $191 million in cash compared to $3.1 billion in debt, of which $363 million is short-term debt.
Cintas’s cash and revolving credit facility totals around $791 million, providing adequate funds for normal business operations. Given, the company’s track record of consistent cash flow generation and Moody’s “A3” credit rating, Cintas appears to have plenty of firepower to continue acquiring smaller rivals without jeopardizing the dividend.
Cintas’s Dividend Growth
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Cintas has some of the best dividend growth potentials of any stock with a Dividend Growth Score of 99. The company is a dividend aristocrat and last raised its dividend by 27% in 2016, marking its 34th consecutive annual dividend increase.
Cintas has grown its annual dividend by approximately 20% and 14% per year over the last five and 10-year periods, respectively. With a long runway for steady earnings growth and relatively low payout ratios, dividend growth should continue at a healthy double-digit rate for the foreseeable future.
Valuation
CTAS trades at a forward P/E ratio of 25.7 and has a dividend yield of 1%, which is slightly lower than its five year average dividend yield of 1.2%.
The company’s dividend yield is low because it doesn’t pay out much of its earnings, choosing instead to reinvest most of its profits back into the business for long-term growth.
As a result, Cintas has increased its EPS by double-digits over the last six consecutive years ending in fiscal year 2016, a feat accomplished by only 5% of S&P 500 companies.
Given the slow-changing nature of the industry, the company’s recent acquisition of G&K (and the synergies it brings), and Cintas’s advantages as the largest player, the company seems likely to continue generating at least a mid to high single-digit earnings growth over the next five years.
If this plays out, the company appears to offer 7% to 9% total return potential (1% dividend yield plus 6% to 8% annual earnings growth).
However, the stock’s high P/E ratio provides very little margin for error. The stock would look more interesting at a forward P/E ratio closer to 20 (i.e. a share price near $110), which is still a premium that gives Cintas credit for its strong business quality and above-average earnings growth, but not excessively so.
Conclusion
Cintas is a boring yet remarkable business. Few companies have survived for so long doing basically the same thing (especially something so simple as providing uniforms and doing laundry).
With a number of meaningful competitive advantages and one of the best outlooks for long-term dividend growth, Cintas is a company worth watching for a better entry point.
Investors seeking more income can review some of the top high dividend stocks here instead.
Leave A Comment