Stock of the week: Cintas

Summary:
- Cintas is the US business services company
- Leader in the US uniform rental industry
- Solid and sustainable dividend policy
- Business performance linked to the condition of the US labour market
- Cintas (CTAS.US) marches towards recent highs after bouncing off the 200-session moving average

Release of the NFP report for March is looming large and data will be watched closely by investors from all around the world. Tight labour market can be seen as a hurdle for many companies as it makes hiring new employees harder and more costly. However, there is one stock that is especially interested in seeing high US employment - Cintas. In this analysis we will take a look at the company's business, latest earnings report and analyze dividend safety.

Cintas enjoyed stable revenue growth for the major part of the post-crisis decade. An acquisition of G&K Services at the end of fiscal 2017 provided solid revenue and earnings boost for the company. Source: Bloomberg, XTB Research

Cintas is the US company operating in the business services industry. For almost 90 years the company was providing US businesses with uniform rentals and laundry services. Following an acquisition of Unitog in 1999, the company became the largest uniform rental company in North America. Numerous acquisitions allowed Cintas to expand its offering into other services like, for example, providing first aid supplies to firms or running different types of training courses for their employees. In fact, when it comes to basic or safety equipment in the workplace, like for example uniforms or fire extinguishers, the US companies can get virtually everything they need from Cintas. This brings us to the key macroeconomic measure for Cintas business - US employment.

While need for first aid supplies or carpet cleaning services may or may not increase with the overall strength of the US labour market, demand for Cintas’ core business - uniform rentals - certainly should. Tight labour market results in bigger demand for uniforms or, in case of having its own uniforms, for laundry services. Cintas is one of the few companies in its industry that operates on the country-wide basis so employment change figures presented in the NFP reports for the whole economy can be very useful when assessing demand for Cintas’ services in the future. Having said that, one can rule that the stock’s performance should be similar to the one of the broad market and this is exactly the case. Cintas has beta of 1.08 showing that its stock price tends to move more or less in tandem with the S&P 500 (US500) index. However, as we are in quite an uncertain macroeconomic environment right now, the question remains how is Cintas coping with it? We can find answers in financial report for the third fiscal quarter of 2019 (December 2018-February 2019).

Cintas managed to greatly boost its margins during the decade following global financial crisis. Rising profit margin in the past few quarters was a result of integrating recent acquisitions.  Source: xStaiton5

Cintas released earnings report for the third quarter of fiscal 2019 on 21 March. The company reported revenue of $1.68 billion, 5.8% higher than a year ago and slightly lower than markets’ expected. Scott Farmer, CEO of Cintas, named abundant holiday calendar in December-February period as well as one-offs like exceptionally unfavourable weather conditions as reasons behind customer closures that led to disappointing sales. The company also experienced quite significant decline in profit. However, it was mainly due to the unfavourable base effect (positive impact of the US tax reform on last year’s earnings). Following an adjustment for one-offs the company managed to beat the highest earnings estimate provided by Bloomberg. The company also managed to improve its margins.

However, it was not earnings per se that caused Cintas stock to drop in the aftermath of the release. The company lowered the upper limit of the revenue guidance range for the fiscal 2019. Earlier, the company expected that sales in June 2018-May 2019 period will fall in $6.87-$6.91 billion range while now it expects revenue of $6.87-$6.89 billion. While downward revision is surely an unwanted development, one should keep in mind that the Federal Reserve stroke a dovish tone during Cintas’ third fiscal quarter signalling that the US economy may be heading for a slowdown. In case this is true, outlook for Cintas should deter as even if employment does not fall, it is likely to stop rising so robustly. Nevertheless, the company does not seem to be too much concerned about it, at least for now. With updated guidance Cintas still sees revenue rising 6.1%-7.3% YoY in the final quarter of the fiscal 2019, more or less in line with the pace of growth in the previous years.

Cintas has been rising dividend payout for 32 consecutive years now. An abnormal spike in fiscal 2015 was due to the payout of special dividend related to the Shred-It merger. Source: Bloomberg, XTB Research

We’ve concluded that level of employment in the US economy is crucial for Cintas. Having said that, one could argue that one should avoid the stock at all cost during recession periods. Indeed, between 2007 peak and 2009 trough Cintas underperformed S&P 500 slightly. Despite this, the company still may look attractive for long-term investors due to its solid dividend policy. Cintas is one of the so-called Dividend Aristocrats - stocks that have a record of at least 25 years of consecutive dividend payout increases. Cintas has kept increasing its dividend payout for over 30 years now. As one can see on the chart above Cintas did not pay a single dividend exceeding either its EPS or free cash flow per share since the turn of millennia. Dividend payout ratio in the 20-50% range during the period hints at responsible and sustainable dividend policy.

Cintas (CTAS.US) stock experienced some heavy declines in the final quarter of 2019 when S&P 500 (US500) plummeted. Nevertheless, just like the US index the stock had a stellar beginning of the year and is trading 33% higher YTD. The stock has been moving higher as of late following a bounce off the 200-session moving average. Source: xStation5