Cintas Not Scintillating

By Stephen D. Simpson, CFA | September 22, 2010 AAA

These are lousy times to be in the business of providing services to business. Whether you look at payroll and HR service companies like Paychex (Nasdaq:PAYX) and ADP (NYSE:ADP), staffing companies like Manpower (NYSE:MAN), or sanitation service providers like Ecolab (NYSE:ECL), the combination of stagnant employment and cost-cutting has been a headache for almost every player. As the leader provider of uniform rentals in North America, Cintas (Nasdaq:CTAS) is likewise caught up in that malaise.

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The Quarter That Was
All things considered, Cintas likely made the best of a difficult situation in the company's fiscal first quarter. Overall revenue growth exceeded 3%, with organic revenue growth of just under that figure. Although core uniform rental revenue was barely positive, at least it was positive, unlike the negative organic revenue performance in the prior quarter. On the other hand, the company did see solid double-digit growth in both uniform sales and document management.

Below the revenue line, the performance was more mixed. A favorable tax rate helped the bottom line result, but operating margin did decline this quarter. Gross margin slid a bit on higher energy and maintenance costs, but it was higher sales costs that compressed margins most. The company was not exactly specific about whether the sales expansion is to continue to build the fire and safety and document businesses or reignite the uniform rental business (or both), but it seems safe to assume that competing with the likes of Tyco (NYSE:TYC) and Iron Mountain (NYSE:IRM) requires ongoing spending on the SG&A line.

The Road Ahead
Although the growth of the uniform rental market has trailed the growth of the overall economy, it nevertheless stands to reason that Cintas needs to see the economy (and especially hiring) pick up for business to improve. That is almost certainly a "when, not if" question, but a multi-year slow-growth recovery would likely be a severe test of investor patience.

On the other hand, the company does have those newer lines of business to consider. Cintas' move into fire/safety and document management is still a bit of a puzzle to me. I appreciate the company's desire to diversify and continue to grow the business. On the other hand, the relative returns on capital for Iron Mountain and the fire/safety businesses of Tyco and United Technologies (NYSE:UTX) make me wonder why the company could not have identified higher-return markets as potential targets for expansion.

The Bottom Line
For investors who share the belief that ongoing growth in non-uniform businesses are likely to shrink the company's free cash flow margin and returns relative to historical levels, Cintas' stock looks more or less fairly valued. (To learn more about free cash flow, see Free Cash Flow: Free, But Not Always Easy.)

Perhaps Cintas will bring a new way of doing business to these markets and maintain its returns. Likewise, maybe the company will see a bigger recovery in the uniform business than current conditions suggest. On the other hand, maybe investors should take a look at other ideas like the aforementioned Paychex, Manpower or Ecolab to play the eventual recovery in business activity.

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