Cintas Corp. (CTAS) and G&K Services (GKSR) are two of the largest suppliers of uniforms for corporate sale and lease in North America. Cintas is the biggest player in the group by market capitalization ($4.3 billion) and revenues (about $3.7 billion annually), while G&K ranks third in sales ($625 million and $825 million, respectively). Although these companies operate in a relatively mature market, their earnings prospects should improve substantially along with a rebounding domestic economy.
Revenues from uniform rentals are highly correlated to employment levels, particularly within economically sensitive industries, such as manufacturing, which represent the core markets for Cintas and G&K. In 2008, when the financial crisis hit, the operating conditions in the uniform rental market took a turn for the worse, as millions of Americans lost their jobs. To compensate, these companies have focused on cost reduction initiatives, while waiting for employment to pick up. Even so, the stock prices of both Cintas and G&K fell substantially during the recent recession.
However, the price of G&K stock has rebounded more than 40% over the past six months. Strong results during the first half of fiscal 2011 have caused G&K management to raise its adjusted earnings guidance in recent quarters, contributing to some of this gain. Continued stabilization in economic conditions, and the likelihood of an uptick in the employment rate in fiscal 2012, appear to have increased investor interest in the uniform rental sector. Indeed, UniFirst (UNF) stock has also risen nearly 30% over the past six months. UniFirst is the second-largest provider of uniform rental services in the United States.
Meanwhile, Cintas appears to have been overlooked by many investors. Indeed, the stock missed the recent rally in the broader market and is up only 7% during the past six months. Cintas, which is nearly four times the size of its closest peer, UniFirst, by market capitalization, should benefit from the same positive employment trends as the rest of the industry. Revenue growth is likely to lag gains in hiring by six to nine months, but an improving economy could begin to have positive effects on Cintas’ top line as soon as fiscal 2012.
As the largest player in the uniform rental market, we believe that Cintas has a potential advantage over its competitors in terms of operating leverage. It costs Cintas nearly nothing to rent an additional uniform to one of its clients and, therefore, once hiring trends improve; each additional employee is almost pure profit. With a larger distribution footprint, Cintas should be able to expand its operating margin at a faster rate. Indeed, if employment gains are strong, Cintas’ operating margin could surpass 20% by mid decade, something it has not done since 2005.
Moreover, Cintas has the advantage of being involved in more than just the uniform rental business. The company also operates businesses in the first aid, safety and fire protection, and document management arenas. These emerging businesses, as Cintas refers to them, are likely to grow at a faster rate than the core rental division. These offerings comprised 18% of Cintas’ top line in the fiscal second quarter of 2011, and are likely to become increasingly important contributors to the company’s operating results going forward.
At present, it is our opinion that Cintas is the most appealing play for investors interested in this segment. As the largest company in the industry, Cintas is the best fit for conservative investors. The issue may also appeal to accounts with a growth and income focus, as Cintas offers a more generous dividend then it’s competitors (though the yield is modestly below the Value Line median) and has the best prospects for price appreciation over the next 3 to 5 years, since a recovery of the uniform rental market is not reflected in the current quotation, unlike its peers.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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