Performance Beyond the Uniform

04/22/2008 12:00 am EST


Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, equities strategist and editor of Morningstar Stock Investor, says leading uniform-rental company Cintas posts great sales and earnings growth year after year.

Cintas (Nasdaq: CTAS) is the leader of the uniform industry. With more than 800,000 customers, it designs, manufactures, rents, and sells uniforms to businesses; roughly five million employees wear its uniforms every day. Cintas also provides ancillary products such as entrance mats, restroom supplies, first-aid and safety products and services, and document-management services.

With about 30% share of the $7-billion US market, Cintas's substantial size advantage allows for better volume discounts from suppliers while keeping overhead costs low as a percentage of sales. Consequently, Cintas enjoys an operating margin that is nearly twice that of its closest competitor.

Further augmenting Cintas's wide moat is an extremely fragmented base of customers, none contributing more than 1% of total revenue. This lopsided relationship with clients gives Cintas the bargaining power to structure favorable long-term contracts.

As the uniform business matures, Cintas is expanding its portfolio of nonrental services (25% of revenue), which consist mostly of uniform sales, first aid and safety, and document management. Cintas's customers already outsource certain functions and, therefore, may be receptive to new service offerings. Although these ancillary businesses are presently not as profitable as rentals, return on investment should improve as these new offerings gain scale.

Scott Farmer, 48, has been chief executive officer since 2003 and has served Cintas for more than 20 years. His father, Richard Farmer, is Cintas's founder, former CEO, current chairman, and largest shareholder, with 11% of shares outstanding.

Cintas's management ranks highly in shareholder stewardship. In 2007, executive bonuses were eliminated because earnings growth missed company goals. During the last three years, fewer than 1% of shares outstanding have been granted as options, with much of the issuance spread below the executive level. Overall performance has been commendable-revenue, income, and dividends have increased annually for more than two decades, and return on invested capital is solid.

Our fair value estimate remains $47. (It closed above $29 Monday-Editor.) We forecast revenue growth to average 8% during the next ten years, including 5% internal growth and about 3% through acquisitions. Behind [that] assumption is Cintas's history-it acquired 37 companies in both 2004 and 2005 and several more in 2006 and 2007. We forecast gross margins to remain approximately constant at 43%. Operating margins during the last ten years averaged 16%, and we expect them to average about 15% through 2017.

Investors face two primary risks-Cintas's acquisitions in new lines of business and employee discontent. Despite these concerns, we derive great comfort from management's admirable record: It has produced 38 consecutive years of revenue and income growth, along with 24 years of dividend increases. We believe Cintas is a below-average-risk investment and are confident that its economic moat will remain intact.

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