Dividend Aristocrats in Focus Part 46: Cintas - Sure Dividend Sure Dividend

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Dividend Aristocrats in Focus Part 46: Cintas


Published by Bob Ciura on November 21st, 2017

For the best-in-class dividend growth stocks, look to the Dividend Aristocrats. This is a select group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases.
 

We review all 51 Dividend Aristocrats each year. The next stock in the 2017 edition is Cintas (CTAS).

Cintas is a high-growth dividend stock. It has raised its dividend 34 years in a row, including a 22% increase on October 17th.

Cintas raises its dividend each year, but it has a low current yield of just 1%. In addition, it has a dangerously high valuation.

Future returns of the stock could be poor, if the valuation returns to historical levels. This article will discuss why we currently rate Cintas as a sell.

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. Cintas generates annual revenue of more than $5 billion.

CTAS Overview

Source: Investor Relations

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.

The company is split up into three main businesses. The Uniform Rental and Facility Services segment is the largest business, representing more than 75% of annual revenue. It provides products and services to customers through the company’s local delivery routes.

Cintas also has a first aid and safety services business, which provides products through its distribution network and local delivery routes.

Cintas is a growth company. In fiscal 2017, revenue and earnings-per-share rose 11% and 4%, respectively.

Going forward, Cintas should continue to generate earnings growth in the high-single to low-double digits each year.

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. This has led to the huge rally in Cintas stock since the market lows of 2009.

CTAS Growth

Source: Investor Relations

Cintas has continued to post strong growth this year. Revenue increased by 27% in the most recent quarter. Organic revenue, which excludes the impact of acquisitions, rose 8.3%. Along with cost controls and share repurchases, earnings-per-share increased 18% last quarter.

The company also increased guidance for the upcoming year. Fiscal 2018 revenue is expected in a range of $6.3 billion to $6.4 billion. Earnings-per-share from continuing operations are expected in a range of $5.30 to $5.38.

Cintas has a positive growth outlook moving forward. Catalysts for future growth include a recovery in the oil and gas industry, as well as a restructuring of the company’s product portfolio.

Plus, Cintas will benefit from global economic growth. As companies grow and hire new employees, demand for service uniforms and related equipment rises.

Another growth catalyst for Cintas is its portfolio restructuring. The company has divested of under-performing segments, and has acquired companies in new areas.

For example, Cintas sold its interest in Shred-it International, for $578 million. This business was not meeting management’s expectations, and was not deemed critical to the future growth strategy of the company.

It also acquired G&K Services for a total enterprise value of $2.2 billion. G&K Services will add approximately $1 billion of annual revenue to Cintas and will give the company a stronger grip on the branded uniform and facility services industry.

Based on fiscal 2017 results, management expects revenue and earnings-per-share to increase 19% and 12%, respectively, for the full year.

Competitive Advantages & Recession Performance

Cintas has a distinct operating advantage, which is its vast distribution network. Cintas has approximately 11,000 local delivery routes, 528 operational facilities, and 11 distribution centers.

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.

This helps keep competition at bay. It would take an enormous amount of start-up capital to even approach Cintas’ operational size.

Its distribution capabilities and reputation for quality, provide Cintas with high margins. For example, in fiscal 2017 Cintas generated a 44% gross margin.

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 experienced Cintas had a difficult time growing earnings-per-share, despite the fact that the recession officially ended in 2010.

The company’s earnings-per-share for 2008-2012 are shown below:

As you can see, Cintas struggled during 2008 and 2009, 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.

And, Cintas quickly emerged from the recession. The company grew earnings-per-share by 13% and 35% in 2011 and 2012, respectively.

Valuation & Expected Returns

Cintas stock trades for a price-to-earnings ratio of 29. This is a fairly high valuation, as the S&P 500 Index trades for an average price-to-earnings ratio of 24.8.

And, Cintas is valued at a significant premium to its own historical valuation.

CTAS Valuation

Source: Value Line

Cintas has had an average price-to-earnings ratio of 17.7, which means the stock is currently trading 64% above its 10-year average. The stock has not traded above 30 times earnings since 2002, just before it experienced a prolonged period of multiple contraction.

If the stock were to return to its 10-year average price-to-earnings ratio, shares would decline approximately 39%.

As a result, Cintas is overvalued, and is a confirmed sell for us at any price above $129 per share. This would represent a price-to-earnings ratio of 24, on par with the S&P 500.

According to ValueLine, Cintas increased earnings-per-share by approximately 7% per year over the past 10 years.

Combined with dividends, Cintas’ total returns would be as follows:

In this forecast, total returns would reach 7% to 9% per year. However, a contracting price-to-earnings ratio would severely impact total returns.

For example, If Cintas’ valuation multiple declines to 18 over the next 6 years, the company’s total returns will be reduced by about 6% each year.

Therefore, we expect total returns in the low-single digits for Cintas going forward.

Final Thoughts

Cintas is a very strong company, with a high growth rate of earnings and dividends.

Due to the impressive rally in the stock price over the past several years, Cintas now has a dangerously elevated valuation. Another consequence of the huge share price increase in recent years is that the stock has a low dividend yield of 1%.

While the company has a secure dividend payout with room for future dividend increases, the stock is overvalued.

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