I recently reviewed UniFirst’s (UNF) quarterly results. I thought it was a good summary of what I’m expecting this earnings season. Furthermore, while I have no idea what tomorrow’s job report will show, the uniform companies aren’t a bad place to look when analyzing employment trends. Cintas (CTAS) also announced earnings recently. Cintas reported solid results, but spent most of its conference call talking about its G&K Services acquisition. UniFirst discussed the current operating environment in more detail and generated results that I believe closely resemble the broader economy.
Earnings Season
UniFirst’s core laundry business grew revenue 2.2%. A low single-digit growth rate is commensurate with a mature economic cycle and what I’m expecting for nominal GDP this quarter. Management noted its business is stabilizing, particularly in its energy-related markets. As I’ve stated in past posts, corporate earnings growth in recent quarters has been aided by easy comparisons in energy-related and industrial businesses.
As it relates to its energy markets, management stated, “UniFirst witnessed significant uniform wearer losses in the niche markets over the last couple of years that affected our top and bottom lines. But more recently, we’ve been seeing not only stabilization in these areas, but actually some slight gains in energy-related uniform wearers. It would be premature for us to project any future growth opportunities in these volatile markets, but these modest improvements in uniform wearers have been more than welcome to say the least.”
The rebound in energy-related business shouldn’t be surprising. According to Baker Hughes (BHI) the average rig count for February 2017 was 744, up from 683 in January 2017 and up 212 from 532 in February 2016 (a 40% increase from a year ago). With many exploration and production companies hedging a meaningful portion of this year’s production, I believe capital expenditure budgets for 2017 will remain relatively stable. As such, I expect easy comparisons in energy-related businesses to continue for the next couple of quarters (rig counts bottomed in May-June 2016).
UniFirst also noted they were optimistic as it relates to government and policy. Management stated, “We are also hopeful that with the new presidential administration, national employment levels and the overall economy will soon begin reaping the benefits as a result of its new policies and from loosening up some of the business-related regulations. So we are watching these areas very closely as we move forward to identify any potentials for additional business and related growth opportunities.”
Has growing optimism spilled over into improving business trends? “From the customer visits that we’ve been making over the last quarter, I think there’s a general business hopefulness that this gentleman and the President of the United States will spend some money on infrastructure and maybe military spending to get more jobs going, but everybody is kind of wait and see.”
On rising costs and wages management stated, “They really have been filtering in. I think a number of states have increased minimum wages. And although most of our employees are above those minimum wages, it does cause sort of a wage compression right up the chain. And so we’ve been moving and having to pay more to hire certain positions from the production level up through the service level.”
Management also noted they expect pricing to improve after Cintas recently acquired G&K Services. When asked about the acquisition management said, “I think we’ll get a little more rationality on the pricing side.”
Management commented on the current operating environment, stating, “Yes. We would say we’re operating right now in more of a normal environment, which is not really a big pull from wearers, but it’s not a drag either, so sort of stable and that’s our assumption. Ron mentioned we are seeing some pockets of positive adds in some of the energy markets, but again not overly significant. So we don’t have anything built in that’s a big pull or tailwind.”
And finally, I thought the following comment related to the reduction in growth caused by lower energy-related sales was interesting. In effect, management believes lower energy-related sales reduced the company’s overall organic growth rate by 1% (from 3% to 2%). In my opinion, this is similar to what the overall economy experienced with a 1% reduction in GDP after the energy credit boom turned to burst (GDP was averaging 2-3% before the energy bust and 1-2% after).
Specifically, management stated, “What I will say is that we’re 2 quarters in now to really not having seen those reductions from the energy sector. And once we sort of get another couple of quarters through, we’ll sort of have annualized that impact…without some of those reductions, our organic growth probably would have been in about that 3% range” [currently growing 2% organically].
In conclusion, I’m expecting this quarter’s earnings season to be similar to Q4 2016, with slow to moderate growth on average. I’m expecting organic sales growth and nominal GDP to remain in the low single-digits. We’re not in a recession, nor are we in a booming economy. I believe we will also continue to see a growing dispersion between industries. As noted last quarter, energy-related and industrial businesses will benefit from easier comparisons – some growth should be anticipated. I also expect consumer discretionary businesses will continue to struggle, with companies more closely tied to asset inflation, such as home improvement, performing better.
I will provide a more detailed overview of current operating trends as the facts and earnings reports roll in. Similar to last quarter, I’ll also try to put together a summary of company operating results. I know these summaries are long, but if you can find time to read them, I think you’ll find it worthwhile. I continue to believe economic data derived from hundreds of operating companies is more timely, accurate, and valuable than government data.
For those attempting to guess tomorrow’s job number, good luck! Given all of the adjustments made to the data, I have no idea what the government will report. However, based on the results of the uniform companies, I wouldn’t be surprised if the number shows some improvement, especially in wages. I continue to see wage pressures and have been curious as to why this hasn’t showed up in the government data. Maybe tomorrow…
Article by Absolute Return Investing with Eric Cinnamond
