CTAS Cintas Corporation

We have recently downgraded Cintas Corporation (CTAS) from Outperform to Neutral as the positives like solid organic growth and margin expansion are undercut by headwinds from cotton and energy prices and an uncertain economic environment.

In the first quarter of 2012, Cintas reported earnings of 52 cents per share, comfortably surpassing the Zacks Consensus Estimate of 47 cents and 30% higher than the 40 cents earned in the year-ago quarter. Strong performance across all its business segments helped the company to deliver better-than-expected results.

Total revenue in the quarter under review increased 10.1% to $1.02 billion, striding ahead of the Zacks Consensus Estimate of $0.998 billion. The quarter marked the second consecutive period of double-digit revenue growth.

Cintas, in fiscal 2012, expects to generate revenue in the band of $4.0 billion to $4.1 billion and EPS in the range of $1.97 to $2.05. The Zacks Consensus Estimates for revenue and EPS are at $4.075 billion and $2.04, respectively.

During the recession, Cintas sharpened its operations by evaluating sales force productivity, optimizing routes and streamlining labor overhead. The company returned to year-over-year organic revenue growth in mid-2010 not looking back since then. In the recently reported quarter, the company posted solid organic growth of 7.6%, reflecting the sixth consecutive quarter of a year-over-year rise. The organic growth of 7.6% was almost on par with a rise of 8% recorded in the fourth quarter of 2011, marking a five-year high and a distinct improvement over the 2.8% growth recorded in the year-ago quarter. Though the macro environment can limit Cintas’ growth prospects, the company has the wherewithal to drive growth by adding additional salespersons and increasing sales productivity.

On the margin front, Cintas continues to expand through better sales productivity and cost efficiencies, offsetting the rising headwinds from higher energy and other input costs. During the first quarter of fiscal 2012, gross margin increased 60 basis points to 43.2% and operating margin expanded an impressive 170 basis points to 12.6%, the third consecutive quarter of strong operating margin expansion after several years of declines. This performance was commendable considering the ongoing headwinds from higher energy and garment material prices.

Cintas recently raised its quarterly dividend by 5 cents to 54 cents, the 29th straight year of the company’s dividend hike, translating into a 10.2% increase from the prior dividend of 49 cents. The company has religiously hiked its dividend each year starting from 1983, the year it went public. We believe Cintas’ solid balance sheet and cash flow characteristics support a renewed repurchase authorization and a dividend hike.

On the flipside, Cintas draws 70% of revenue from its core uniform rental segment, which is in the saturation stage. The company is constantly making efforts to innovate and focus on its other businesses, including direct uniform sales, first aid safety, fire protection and document management. However, in doing so, the additional resources and time involved in developing these growing segments may affect Cintas' profitability.

The quarter was plagued by rising costs such as cotton for uniforms and diesel fuel for trucks. These costs could pressure profitability in 2012, particularly in the Rental segment. Management reiterated expectations for a $15 million impact from higher cotton prices.

Cintas’ revenue largely depends upon the service industry, including hotels, airlines, restaurants, etc. Any drop in the employment rate can adversely impact the company’s profitability.

We have thus downgraded our recommendation on Cintas Corporation from Outperform to Neutral. The quantitative Zacks #2 Rank (short-term Buy rating) for the company indicates upward pressure on the stock over the near term.

Cincinnati, Ohio-based Cintas Corporation designs, manufactures and implements corporate identity uniform programs, and provides entrance mats, restroom supplies, promotional products, and first aid and safety products for approximately 900,000 businesses. Cintas competes with G&K Services Inc. (GKSR) and privately held Alsco Inc. and ARAMARK Corporation.

 
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