Contents

Summary

  • This Cintas Corporation stock analysis is based on Q1 2018 results released September 26, 2017.
  • Cintas completed the transformative acquisition of one of its largest competitors (G&K Services, Inc.) earlier this year and integration is proceeding as planned.
  • Valuation is stretched with a forward PE of ~27 versus the historical ~20 – 21 level.
  • The dividend is paid annually. Unless you are a shareholder of record as at November 10, 2017, you should not expect to receive a dividend until December 2018.

Introduction

As part of a well diversified portfolio I invest in well capitalized companies with significant competitive advantages in the following 5 economic sectors:

  • Manufacturing & Industry
  • Resources & Commodities
  • Consumer
  • Finance
  • Utilities

You will notice the companies in which I have invested are predominantly highly recognizable names. I will, however, periodically look for potential investment opportunities that are well down the list of Fortune's list of companies; in today’s post, I look at #520.

I first looked at Cintas Corporation (NASDAQ: CTAS) as a potential investment in 2014. I quickly backed away, however, when I learned it had entered into a partnership transaction in May 2014 with the shareholders of Shred-It International Inc. to combine CTAS’ document shredding business with Shred-It’s document shredding business.

In the early 2000s I had dealings with Shred-It when it was privately owned. The company was continually financially challenged and subsequent to my dealings with the company, I noticed new participants in the industry which I presume would have only made things worse for Shred-It.

I paid no further attention to CTAS until very recently. In doing my due diligence I learned that in July 2015 it announced an agreement to sell its interest in Shred-It to Stericycle (NASDAQ: SRCL); the deal closed October 2015.

As part of my CTAS research I see that it acquired one of its competitors (G&K Services, Inc.) in March 2017 for ~$2.2 billion, including acquired net debt; this certainly was a sizable acquisition for CTAS as it represented ~18% of its total market cap.

Business Overview

CTAS provides a wide range of products and services that enhance customers' image and helps keep their facilities and employees clean and safe. It serves in excess of one million businesses primarily in North America as well as Latin America, Europe and Asia.

The primary markets served by the various CTAS businesses are local in nature and highly fragmented. It competes with national, regional and local providers, and the level of competition varies by geographic location. CTAS offers its clients product, design, price, quality, service and convenience.

CTAS’ products and services include uniforms, floor care, restroom supplies, first aid and safety products, fire extinguishers and testing, and safety and compliance training.

Its organizational structure consists of the following reportable operating segments:

  • Uniform Rental and Facility Services (URFS);
  • First Aid and Safety Services (FASS);
  • All Other.

The URFS includes G&K. It consists of the rental and servicing of uniforms and other garments including flame resistant clothing, mats, mops and shop towels and other ancillary items. In addition, restroom cleaning services and supplies, carpet and tile cleaning services and the sale of items from its catalogs to customers are included within this reportable operating segment. The products and services within this operating segment are distributed through local delivery routes originating from rental processing plants and branches.

The FASS consists of first aid and safety products and services. The remainder of CTAS’ business, Fire Protection Services and Uniform Direct Sale, is included in All Other.

The products and services within the FASS and All Other operating segments are provided via CTAS’ distribution network and local delivery routes or local representatives.

CTAS' growth strategy is to achieve revenue growth for all of its products and services by increasing penetration with existing customers and the broadening of the customer base to include business

segments to which CTAS has not historically served. CTAS also strives to identify additional product and

service opportunities for current and future customers. Growth by acquisition, as in the case of the G&K Services, Inc. acquisition in March 2017, is another manner in which CTAS intends to grow revenue.

Q1 2018 Results

On September 26, 2017, CTAS announced Q1 results for the period ending August 31, 2017. EPS, net of the G&K transaction and integration expenses, increased 17.5% relative to Q1 2016. Management attributed the 27.2% increase in Q1 revenue ($1.61B) relative to Q1 2016 largely to the G&K acquisition.

As a result of the acquisition, the Goodwill on CTAS’ balance sheet ballooned by $1.508B from Q3 2017 to Q1 2018. This is a ~116% increase.

CTAS’ leverage has also increased dramatically. The Q1 2018 long-term debt relative to shareholders’ equity now stands at 126% versus ~53% in Q3 2017 (pre-acquisition closure).

Dividend, Dividend Yield, and Free Cash Flow Coverage

CTAS recently announced a dividend increase for the 34th consecutive year.

Investors seeking a stream of dividend income are going to be disappointed to learn that CTAS only pays a dividend annually. Readers will be further disappointed to learn that in order to receive the December 8, 2017 $1.62 annual dividend, a 21.8% increase from the previous year, you would have had to be a shareholder of record on November 10, 2017.

You will be hard pressed to find a listing of the company’s historical dividend track record on the company’s website. For ease of reference, I provide the following which reflects the annual dividend for the FY 2008 – FY2017 timeframe.

Source: Morningstar

Note the negligible annual dividend increases during the Financial Crisis.

Based on the current stock price of $145.43, the new dividend will yield ~1.1%. This level is unacceptable to many investors and many want a dividend yield not less than 3%. This dividend yield is highly unlikely to materialize with CTAS any time in the foreseeable future; even a dramatic drop in CTAS’ stock price to $100.00 would only result in a dividend yield of 1.62%. Unless a nominal dividend yield is of minor importance to you, I strongly suspect CTAS has suddenly lost its appeal as a potential investment.

CTAS generated $0.491B in free cash flow in FY2017. As at August 31, 2017, CTAS had 106,179,574 in outstanding shares. With the new annual dividend of $1.62, CTAS has to pay out ~$0.172B in dividends which is ~35% of its FY2017 free cash flow. This low ratio provides CTAS with adequate room for continued dividend growth. In addition, some improvement may be experienced if management’s estimated $0.13B - $0.14B in synergies over the next 4 years materializes.

Valuation

The current mean FY2018 adjusted EPS projections from various brokers is $5.36.

Source: TD WebBroker

On November 9, 2017, CTAS closed at $145.43. Using the $5.36 estimate from above, the forward PE is ~27. I view this as well beyond a prudent level.

Investors are pricing CTAS to perfection. Should CTAS’ PE revert to historical levels (~20 - 21) then a price closer to ~$107 - $113 seems to be a range where I would be prepared to give serious consideration to initiating a position in CTAS.

Source: Morningstar

Cintas Stock Analysis - Final Thoughts

I view the G&K acquisition as being far more synergistic than the Shred-it deal. While the closing of the acquisition is relatively recent, management indicates the integration of G&K is proceeding according to plan.

CTAS appears to be a very well run company and has rewarded long time shareholders. Initiating a position in CTAS at the present time, however, does not appear to be prudent. The drawbacks I see are:

  • CTAS only pays a dividend annually. This in itself is not a deal breaker for me but it may be for some readers;
  • The dividend yield, based on the upcoming $1.62 annual dividend, is ~1.1%;
  • I suspect CTAS thrives during a robust economic period but can get hit hard in an economic downturn when its customer base starts downsizing;
  • The G&K acquisition has resulted in a much higher leveraged balance sheet relative to the past few years;
  • The stock is trading at a lofty valuation and a reversion of the PE to historical levels should not come as a surprise.

In my opinion, this is not an opportune time to invest in CTAS. I suspect that in the future there will be opportunities to invest in CTAS at far better valuation levels.

I hope you enjoyed this post and I wish you much success on your journey to financial freedom.

Thanks for reading!

Note: I sincerely appreciate the time you took to read this post. As always, please leave any feedback and questions you may have in the “Contact Me Here” section to the right.

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.