Our rating on Cintas Corp. (NYSE: CTAS) is BUY. This well-managed company has a long record of market outperformance and dividend growth. The company, which provides employee uniforms and workplace safety and cleaning services, saw strong growth prior to the pandemic, and, while sales growth has slowed, management is growing earnings through margin expansion. Cintas is well positioned for the future as businesses prioritize employee health and workplace cleanliness during the pandemic and outsource noncore tasks such as laundry services and the maintenance of hand sanitizer stations. The balance sheet is clean. On a technical basis, CTAS shares have been in a long-term bullish pattern of higher highs and higher lows since 2009. On valuation, compared to the industry average (ETF IYJ), the shares are trading at premium multiples, which we think are warranted given the company’s financial strength, experienced management team, and market performance. Our dividend discount model renders a value above $400 per share. Blending our valuation approaches, we arrive at a revised 12-month target price of $390, raised from $360.
Over the past five years, CTAS has also outperformed, returning 280% compared to gains of 80% for the index and 87% for the industry ETF IYJ. The beta on CTAS is 1.49.
Cintas recently reported fiscal 2Q results that topped consensus expectations. The company reported 2Q21 revenue of $1.76 billion, down 4.4%.
The operating margin widened by 200 basis points to 20.1%. Diluted EPS from continuing operations rose 4% to $2.37 and topped the consensus forecast by $0.19. (We note that the company’s reported 2Q EPS included a $0.25 positive impact from an asset sale. The Street seems to be including this one-time gain in continuing operations for FY21, but we are not.) In the first half, earnings from continuing operations totaled $5.15 per share.
During the pandemic, Cintas has been providing a range of new products and services, including laundering services for fluid-resistant isolation gowns, PPE rentals, specialized gloves, and hand sanitizer and sanitizing spray. It is also expanding its business as it helps customers to meet stricter cleaning and safety standards. Management said that customer satisfaction has been high during the pandemic and that many first-time customers have signed contracts for expanded services.
Management did not provide full-year guidance due to pandemic-related uncertainty and, as COVID-19 cases are once again rising, is not providing 3Q guidance at this time.
EARNINGS & GROWTH ANALYSIS
Cintas reports revenue for three divisions: Uniform Rental and Facility Services (80% of 1Q21 net sales); First Aid and Safety Services (11%), and Other (9%). Second-quarter business trends for these segments are discussed below: At the top line, in the Uniform Rental and Facility Services segment, second-quarter revenue declined 3.6% organically – an improvement from the 5.4% decline in 1Q. In First Aid and Safety Services, revenue rose 14.5%. Other revenue, consisting of fire protection services and direct uniform sales, was down 26% organically. The declines reflected the loss of direct uniform sales to companies hard hit by the pandemic, such as airlines, cruise lines, and hotel operators. Management keeps a close focus on expenses. In 2Q, the operating margin widened by 200 basis points to 20.1%, driven in part by a higher gross margin.
FINANCIAL STRENGTH & DIVIDEND
Cintas ended fiscal 2Q with cash of $703 million. Debt was $2.5 billion at quarter-end, and the debt/cap ratio was 41%. Free cash flow of $515 million rose 15.5% from prior year. In 2Q21, the company had an operating margin of 20.1%.
Cintas pays a dividend, and has increased it for 37 years. In October 2020, the company switched from an annual to a quarterly dividend, and raised the annualized payout by 10% to $2.81 per share.
MANAGEMENT & RISKS
Scott D. Farmer has been the company’s chairman and CEO since 1994. Mr. Farmer joined the company in 1981 as vice president of the National Accounts Division. His father, Richard T. Farmer, founded the company in 1956 as a small family business, which subsequently grew into the current Cintas through a series of acquisitions. J. Michael Hansen is the company’s CFO. Mr. Hansen joined Cintas in 1995 as a treasury manager and held positions of increasing responsibility before becoming CFO in 2015. His previous experience includes positions at Ernst & Young and Rockwell International.
The company’s financial goals include mid- to high single-digit growth in organic sales on an annual basis, incremental margin expansion, and double-digit EPS growth.
Management’s strategies are to expand its market, increase market share (the company does business with only 1 million of 16 million businesses in North America) and further penetrate the customer base (penetration rates are generally below 20%).
Cintas faces risks associated with fluctuations in the cost of fuel for its trucks and other equipment. Such fluctuations may be caused by geopolitical tensions, especially in oil-producing countries, as well as by natural disasters and pandemics.
The company may also face pressure from employee unionization, which could raise labor costs and materially affect its profitability. The company has been, and continues to be, targeted by several unions.
Cintas also faces supplier risk through the global sourcing of supplies as well as risks from unfavorable currency translation.
Cintas is subject to strict federal and state employment regulations, and could be hurt by any failure to comply with these regulations. Litigation risks pertaining to employee injuries, customer contracts, and environmental issues are also a concern.
Adverse settlements may materially affect the company’s results.
Cintas Corp. provides fire protection products and services; restroom cleaning services and
supplies; first aid and safety services; carpet and tile cleaning services; and safety and compliance training.
Based in Cincinnati, Cintas is a Fortune 500 company with approximately 40,000 employees. The shares are a component of the S&P 500.
The price/sales ratio of 5.2 is near the high end of the historical average range of 2.0-5.5.
On December 30, BUY-rated CTAS closed at $350.23, up $2.86.