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In today’s article, we will continue our analysis of Cintas (CTAS) that we started with “Cintas: A Good Re-Opening Bet At The Right Price“. If you have not read that article, I recommend you read it first.

As I related in my previous article, Cintas’s services have never been in greater demand due to the health concerns begotten by the virus. Cintas provides a bevy of cleanliness oriented services and products, and businesses’ need for these products will continue to grow. Of course, this assumes that many of these businesses will continue to operate at their former capacity, and the reality is that many will take months or years to return to their former glory, especially in northern regions of the United States.

With new products and services like PPE & automatic touchless sanitizer dispenser, Cintas certainly plays a vital role in businesses reopening safely. In my previous article, I discussed the near-term headwinds for the industry, but as investors, we must understand the long-term trends in a company’s financials before making an investment decision. That is, the long term is what counts, and in the lifespan of a company, one year is truly a blip. With that being said, the initial purchase price plays a large role in the annualized returns one can expect to receive.

With all of this in mind, let’s perform a thorough financial analysis of Cintas, so as to ascertain whether the company is truly worthy of our investment dollars.

Here’s an outline that we will follow:

  1. Financial statement analysis
  2. Dividend analysis

Let’s get straight into financial statement analysis.

Income Statement Analysis

Cintas revenue and gross margins

Source: YCharts

As can be seen above, over the last decade, Cintas’s revenues have increased from $3.6 billion to $7.26 billion at CAGR of ~7.4%. While the revenue growth rate is modest, Cintas has done pretty well when we consider its gross margin expansion from 42% to 46%.

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Higher gross margins can be attributed to greater operational efficiency at Cintas. The primary business segments for Cintas include Uniform Rental and Facility Services, First Aid and Safety Services, Fire Protection Services, and Uniform Direct Sales. Let’s look at the revenue breakdown to get a clear view:

Source: Cintas 10-Q

As we’re all aware, the coronavirus pandemic has triggered a severe economic downturn rendering millions of Americans jobless. If you look at Cintas’ business segments, most of them are dependent on employment and the existence of workplaces.

We saw in our last article how employment growth boosted Cintas’s revenues over the previous decade. To be sure, job growth over the next decade will drive Cintas’s revenues higher as the company garners ~80% of its revenues from the uniform rental and facility services segment. However, some economists have predicted that it would take the economy years to recover from this pandemic shock and get the jobs back, i.e., reach the unemployment levels below 4%, which at present, stands at 13%.

Short-term volatility lies ahead for Cintas with significant headwinds, but the long-term prospects of its business are intact. Furthermore, Cintas is in a strong financial position, which should enable the company to weather the present economic downturn and emerge stronger than ever on the other side.

Balance Sheet Analysis

CTAS balance sheetSource: YCharts

As of February 2020, Cintas had cash and short-term investments worth $234 million and financial debt of $2.74 billion, which translates to a net total long-term debt of $2.5 billion. A Debt to EBITDA ratio of 1.695 is very reasonable for a business like Cintas. However, with the world facing an economic crisis, will Cintas be able to service its debt?

CTAS interest coverage ratio

Source: YCharts

As you can see above, Cintas’s EBITDA of $1.647 billion is almost ~16x its annual interest expense of $104 million. Hence, even if Cintas’ business suffers dramatically in the next few quarters, it could comfortably service its debt. Therefore, Cintas’ balance sheet is certainly strong enough to weather a recession.

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Cash Flow Analysis

Cintas’s free cash flow generation reached a milestone of $1 billion during the previous year, which allowed its management to execute large dividend and buyback programs. In the last twelve months, the company paid out $268 million in dividends and repurchased stock worth $669 million.

Cintas fcf analysis

Source: YCharts

Cintas Offers Rapid Dividend Growth

As we can see in the chart below, the total dividend payout has been increasing, but can it continue in the current environment? The answer is yes. Cintas’s cash dividend payout ratio is only ~25%, thus even if free cash flow were to go down by 75%, Cintas should be able to cover its dividends. Over the last decade, Cintas’s dividend per share grew from $0.48 to $2.55 at a CAGR of 18.18%.

CTAS dividendSource: YCharts

CTAS Dividend HistorySource: YCharts

Cintas has consistently paid growing dividends for over 35 years, which makes it a “dividend aristocrat”. Thus, I fully expect Cintas to continue to pay its dividend this year, as even in a worst-case scenario of 30%-50% revenue declines, the business will generate enough free cash flow to pay its dividends and maintain its aristocrat status.

Buyback Analysis

CTAS buybackSource: YCharts

In the last decade, Cintas repurchased its shares at a rate of ~3.4% per year (from 152 million to 107.6 million). During this time, the size of the buyback program has increased from $0 to $669.4 billion. We can see that Cintas’s management is committed to enhancing shareholder returns via buybacks. However, I think the company may suspend its buyback program for the rest of this year, considering the uncertainty surrounding the virus.

Valuation and Final Recommendation

We already calculated Cintas’s fair value in our previous article (linked in the introductory paragraph). But just to recap, the fair value for Cintas is $192.21, and the expected total return on a ten-year investment at $255 is ~8% CAGR. Hence, even though I like Cintas and expect the company to do well as the economy reopens, the price is not right for me. As I always say, long-term investors should buy great businesses but only fair prices if they want to beat the market. That is, there simply is not enough of a margin of safety for me to buy Cintas. Will it decline from here? Maybe. Maybe not… I honestly don’t know.

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Might it trade sideways for a couple years? I predict that such will be the case, leading to market performance at best, and market underperformance at worst.

Such a situation does not a market-beating stock purchase make.

And therefore…

Key Takeaway: I rate Cintas neutral at $275.

Please feel free to provide your feedback in the comments section. Let me know what you think about Cintas.

As always, thanks for reading; remember to follow, and happy investing!

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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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.