Cintas Corporation (CTAS) is one of the highest scoring dividend stocks in our database for Dividend Safety (98) and Dividend Growth (99). The company has proven to be an extremely durable business with roots dating back nearly 90 years, and it has rewarded its shareholders with higher dividend payments for 32 consecutive years.
This is really one of the most consistent sales and earnings growers around, and it operates in a very slow-changing industry where it maintains leading market share. At the right price, we would certainly considering owning CTAS in our Top 20 Dividend Stocks portfolio.
After 10.1% Return In 2020, Mohnish Pabrai Changes Strategy [2020 Letter]
Mohnish Pabrai's flagship hedge fund, the Pabrai Investment Fund II, returned 29.6% in the second half of 2020. Following this performance, the fund returned 10.1% net for the year, underperforming the S&P 500 but outperforming the Dow Jones Industrial Average, which returned just 9.7%. According to a copy of the investment manager's year-end letter to Read More
Cintas – Business Overview
CTAS started out as a laundry service for businesses during the Great Depression and has grown to become the largest provider of uniform programs in North America. As the company has grown, it has added facility services, first aid and safety services, entrance mats, restroom supplies, document management, fire protection, and more to its offerings.
Today, CTAS serves over one million business customers and clothes more than five million workers every day in North America. Approximately 70% of its customers are in the service-providing sector of the economy, and the remaining 30% are in goods-producing industries such as oil, gas, coal, construction, and manufacturing.
Cintas – Business Analysis
In some ways, CTAS’s business is comparable to a garbage collection company. The business provides each worker with enough uniforms for two weeks. One clean set is for his current workweek, while the other is being laundered and repaired by CTAS.
CTAS will send a rep to the customer’s facility to pick up worn garments and drop off each worker’s clean uniforms for the next week.
It doesn’t take a genius to do laundry, so this commodity business is all about efficiency and being the low cost provider in a particular area (friendly service reps help, too).
With weekly stops made at every customer, route density is the best way to achieve lower costs than competitors because the cost of transportation (i.e. truck trips) can be spread across numerous customers. To accomplish this, CTAS has over 350 distribution facilities and more than 8,000 local delivery routes. Some customers prefer or need to do business with larger players that have more of a nationwide reach, and being closer to customers also results in better service because delivery times are shorter.
Smaller competitors will have miniscule margins if they try to compete in one of CTAS’s established areas because their transportation and operating costs are higher. They would also have to disrupt long-standing relationships that CTAS’s reps have with each customer, although we view that as a smaller competitive advantage. On the other hand, CTAS has the luxury of acquiring these companies to gain new geographies and increase its network density in existing regions, realizing meaningful cost synergies for the acquired businesses.
Once CTAS has a local area locked down for business, it can work on increasing its amount of sales with each customer by offering new products and services such as restroom supplies, document management, and tile cleaning. This strategy reminded us of another dividend aristocrat’s approach – Ecolab’s “Circle the Customer” business model. By offering a wider range off products and services to its customers, CTAS can increase the productivity of its reps, lower its customers’ costs, and create stickier customer relationships.
While it is very competitive and sensitive to price, the rental uniform market has a very slow pace of change and provides an essential service – we don’t believe the majority businesses will start doing their employees’ laundry in-house anytime soon. Furthermore, many of the industries in need of rental uniforms experience high employee turnover, which drums up even more business for companies like CTAS.
These factors have created a relatively stable competitive environment that has helped CTAS gradually grow in size over the decades and give us greater confidence in the company’s long-term relevance. With less than 10% share in a market greater than $40 billion in size, CTAS has plenty of room for growth. We also like the company’s diversification in that no customer accounts for over 1% of its total sales and no end market is greater than 10% of revenue.
Cintas’s Key Risks
We believe CTAS has a lower fundamental risk profile than many other companies. However, its results can be impacted by employment trends, fuel and energy costs, and the health of its end markets (e.g. low oil prices is hurting demand from its oil & gas customers as they reduce their headcount).
However, we don’t believe any of these factors impair CTAS’s long-term outlook. If anything, they could be buying opportunities for patient dividend growth investors.
The longer term issues that could hurt the company’s earnings growth are continued outsourcing of U.S. manufacturing jobs and a potential change in the way businesses choose to dress their employees.
The strong U.S. dollar and higher labor costs have made domestic manufacturers less competitive than overseas competitors, resulting in numerous factory closures and companies choosing to offshore or outsource their operations. Should these trends continue, it could hurt CTAS’s business with goods-producing customers (roughly 30% of its sales).
Not unlike consumers, businesses could also begin to develop a change in taste for their work environments and try to increase employee morale by moving away from uniforms altogether.
However, CTAS’s strong diversification, low market share, and continued opportunities for acquisitions largely mitigate these concerns.
Dividend Analysis: Cintas
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. CTAS’s long-term dividend and fundamental data charts can all be seen by clicking here.
Cintas – Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
CTAS’s dividend is extremely safe with a Safety Score of 98. It scores highly because of its low payout ratios, recession-resistant business, consistent free cash flow generation, and healthy balance sheet.
CTAS’s earnings and free cash flow payout ratios over the last 12 months are 19% and 37%, respectively. As seen below, CTAS’s earnings payout ratio has remained between 20% and 30% most years, which provides plenty of safety and room for continued dividend growth.
During the last recession, CTAS’s sales fell by 4% in fiscal year 2009 and 6% in fiscal year 2010. However, the company’s free cash flow per share actually grew in each of those years, highlighting the defensiveness of CTAS’s business model. While many businesses lay off some employees during economic downturns, their remaining employees still need their uniforms laundered.
CTAS has also done an excellent job generating and growing free cash flow over the last decade. The best business models generate real cash each year that can be used for growth (acquisitions in the case of CTAS) and rewarding shareholders with higher dividends.
CTAS has created value for shareholders by earning a healthy return on invested capital over the last decade. Earning a double-digit return is very good for such a simple business and highlights the company’s competitive advantages.
We can also see that CTAS’s balance sheet is in good shape. The company has about $670 million in cash compared to $1.3 billion in debt. Its free cash flow easily covers its dividend payments and interest expense, and Moody’s assigned the company an “A2” credit rating last year. CTAS has plenty of firepower to continue acquiring smaller rivals without jeopardizing the dividend.
Cintas – Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
CTAS has some of the best dividend growth potential of any stock with a Dividend Growth Score of 99. The company is a dividend aristocrat and raised its dividend by 24% in 2015, marking its 32nd consecutive annual dividend increase.
CTAS has grown its dividend by 15% and 13% per year over the last 5- and 10-year periods, respectively. With a long runway for steady earnings growth and relatively low payout ratios, we expect dividend growth to continue at a healthy double-digit rate for the foreseeable future.
Cintas – Valuation
CTAS trades at about 21x forward earnings and has a dividend yield of 1.2%, which is slightly lower than its five year average dividend yield of 1.3%.
The company’s dividend yield is low because it doesn’t pay out much of its earnings. Instead, it is reinvesting back into the business for long-term growth. This is the appropriate strategy given CTAS’s good returns on invested capital and has resulted in double-digit earnings growth historically.
Given the size of the company’s markets, the slow-changing nature of the industry, and CTAS’s advantages as the largest player, we think the company will continue generating at least a high-single digit earnings growth over the next five years.
If this plays out, the company appears to offer 8-10% total return potential. However, we would like to buy the stock at an earnings multiple below 20.
Cintas – Conclusion
Cintas is a boring yet remarkable business. Few companies have survived for so long doing basically the same thing (especially something so simple as providing uniforms and doing laundry). We think this blue chip dividend stock has a bright future ahead of it and will watch closely for an attractive entry price.