Dividend Aristocrats In Focus: Cintas Corporation - Sure Dividend

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Dividend Aristocrats In Focus: Cintas Corporation


Updated on April 13th, 2021 by Bob Ciura

Rising dividend income over time is a goal for most dividend growth investors. We believe the best way to do this is to focus on high-quality dividend growth stocks.

For the best-in-class dividend growth stocks, consider investing in the Dividend Aristocrats, a select group of 65 companies in the S&P 500 Index with 25+ consecutive years of dividend increases.

You can see a full downloadable spreadsheet of all 65 Dividend Aristocrats, along with several important financial metrics such as dividend yields and price-to-earnings ratios, by clicking on the link below:

 

We review all 65 Dividend Aristocrats each year, and the next stock in the 2021 edition is Cintas Corporation (CTAS). Cintas is a high-growth dividend stock. It has raised its dividend 37 years in a row, including a 6.8% increase for 2021.

Cintas raises its dividend each year, but it has a low current yield of just 0.9%. This is less than half the average dividend yield of the broader S&P 500 Index.

In addition, Cintas stock has an extremely high valuation. As a result, prospective investors should wait for a better price before buying Cintas stock.

Business Overview

Cintas Corporation started out in 1929, under the name Acme Industrial Laundry Company. It was founded by Richard “Doc” Farmer, who got his start collecting chemical-soaked rags from factories and cleaning them for a fee.

Doc Farmer’s grandson, Richard T. Farmer, joined the company in 1956 after graduating from college. After gaining enough experience, he left the family business to start Cintas in 1968.

Today, it is the largest company in its industry, generating annual revenue in excess of $7 billion.

Source: Investor Fact Sheet

It designs and manufactures corporate uniforms, entrance mats, restroom supplies, fire protection, and first aid products. The company has a large and diversified customer base, which includes more than 1 million businesses in North America, Latin America, Europe, and Asia.

Cintas is certainly a growth company, and has been for a long time. Due to its competitive advantages, it should continue to grow in the years ahead.

Growth Prospects

Cintas has enjoyed strong growth for the past several years. It saw particularly high growth rates in the years following the Great Recession, when hiring picked up and the labor market recovered. It again quickly recovered from the coronavirus pandemic last year, even though the unemployment rate spiked for an extended period.

The company continues to perform well. Cintas reported third-quarter earnings on March 17th, 2021 with results coming in better than expectations on both the top and bottom lines. Revenue for Q3 was $1.78 billion, down slightly from $1.81 billion in the yearago period. Diluted earningspershare were $2.37 in Q3, which was up 9.7% from the same period a year ago.

Organic revenue was flat during Q3, which excludes acquisitions, divestitures, differences in workday counts, and forex translation. The organic revenue growth rate for the Uniform Rental and Facility Services operating segment was flat, while the First Aid and Safety Services segment was up 17.7%. As a percentage of revenue, gross margin improved 10 bps to 45.6%. We have raised our estimate for this year to $10 in earningspershare after strong Q3 results.

Cintas has a positive growth outlook moving forward. Catalysts for future growth include the very strong job market in the US as well as Cintas’ willingness and ability to purchase growth, as it did with G&K Services in 2017.

Cintas benefits from global economic growth. As companies grow and hire new employees, demand for service uniforms and related equipment rises. This is how Cintas has been able to produce such high growth rates over time.

Another growth catalyst for Cintas is its portfolio restructuring. The company has divested under-performing segments and has acquired companies in new areas, as management is willing to reshape its portfolio toward the best future opportunities.

In total, we see 6% average annual earnings-per-share growth in the next five years for Cintas.

Competitive Advantages & Recession Performance

Cintas has a distinct operating advantage, which is its vast distribution network. For example, Cintas has more than 11,000 local delivery routes.

It is the largest company in its industry, which gives it market control. It would be very difficult for a new competitor to enter the market and try to disrupt Cintas’ business model, even more so after the G&K purchase. This helps keep competition at bay as Cintas has a highly entrenched customer base. Its distribution capabilities and reputation for quality provide Cintas with high margins.

While Cintas is a high-growth business, it is also reliant on a healthy global economy. When the economy goes into recession, companies hire less and often reduce headcount. This results in reduced demand for the products Cintas manufactures. Cintas had a difficult time growing earnings-per-share during the Great Recession, despite the fact that the recession officially ended in 2010.

The company’s earnings-per-share for 2008-2010 are shown below:

As you can see, Cintas struggled during 2009 and 2010, with two consecutive years of double-digit earnings declines. This reflects how closely the profits of the business are tied to the condition of the economy. At the same time, Cintas remained profitable, which allowed it to continue increasing dividends each year. The company’s dividend also appears to be quite safe at current levels.

And, Cintas quickly emerged from the recession. The company grew earnings-per-share by 13% and 35% in 2011 and 2012, respectively. To be clear, the risk of recession in the near term is low, but shareholders should note that economic downturns are very unfriendly to Cintas’ earnings capabilities.

Valuation & Expected Returns

Based on expected earnings-per-share of $10 for fiscal 2021, Cintas stock trades for a price-to-earnings ratio of 35.3. This is a very high valuation against the broader market, as well as Cintas’ own historical valuations. Our fair value estimate is a P/E ratio of 25 for Cintas stock.

If the stock were to return to our fair value estimate price-to-earnings ratio over the next five years, shares would decline by about 6.7% annually from valuation multiple contraction. As a result, Cintas is significantly overvalued. Earnings-per-share growth (expected at 6% annually) and the 0.9% dividend yield will offset the negative returns from a falling valuation multiple. But overall, total returns are estimated at just 0.2% per year over the next five years.

Cintas’ valuation today, in other words, has nearly priced in five years’ worth of growth and dividends, and we believe investors should avoid the stock as a result.

Final Thoughts

Cintas is a very strong company, with a high growth rate of earnings and dividends. However, due to the recent impressive rally in the stock price, Cintas now has a very elevated valuation.

Another consequence of the huge share price increase in recent years is that the stock has a low dividend yield of under 1%.

While the company has a secure dividend payout with room for future dividend increases, the stock is simply overvalued. We rate it a sell despite its superior fundamentals simply because the valuation is so high.

If Cintas returns to a normalized valuation at or below our fair value estimate, it could once again earn a buy recommendation because of its strong growth and high-quality business.

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