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Cintas
Even after 50+ years, Cintas’ founding family still has sizeable ownership stake at ~14% of the shares outstanding. Scott Farmer is the executive chairman, retiring from his CEO position of 18 years in May of 2021. Whether it’s the family dynamic or some other reason, it seems like the company isn’t too keen on giving out many details about the business (there is no investor presentation and Cintas rarely attends conferences). Interestingly, other companies we’ve analyzed like this were Copart and Costar Group.
Cintas is the leading provider of uniform rental programs to businesses in North America. The company also participates in direct uniform sales and sells products and services related to facilities, first aid/safety and fire protection. Cintas services over 1M enterprise and SMB customers via 11k local routes in over 330 cities. Most industry verticals are represented in the company’s list of customers, but the highest concentration is in manufacturing, auto, healthcare, food services and education.
Uniform rentals and facilities services is the core business segment at Cintas at 80% of revenues. When Cintas signs up a new customer, the company works out a uniform rental program with the customer, which includes uniform sourcing, design, pickup and delivery scheduling, etc. Each worker that needs a uniform gets two weeks’ worth, fitted to size. Cintas drivers pick up the soiled garments and deliver fresh ones each week (as one week’s worth is always at the Cintas’ processing plants). The customer benefits from (1) being able to rely on Cintas to provide high quality uniforms for their workers and (2) not having to put up the upfront capital to purchase and design the uniforms themselves. Customers typically sign a 3 to 5 year contract with minimums and price escalators in place.
In addition to these benefits, the economics of a uniform rental program are also very attractive from a customer’s point of view. According to UniFirst (the third largest player in this industry), a worker that has to purchase and launder work uniforms spends $15/week. If the worker opts to get laundry or dry cleaning service, the weekly expense is $30/week. And according to Cintas, the company charges customers $1-$2/per day that participate in a uniform rental program. Remember, there is no upfront cost of purchasing the uniforms from Cintas.
Because uniform rental programs lack obvious product differentiation (though companies will talk about higher quality fabrics and superior execution like consistent delivery, wash quality, etc.), companies compete based on the quality of service and price. And to offer competitive pricing (while maintaining margins), route density is the name of the game. Drivers go from one or a few pick-up locations (usually a rental processing plant or branch) and drop off/pick up at multiple customers’ sites throughout the day. The more drop off/pick up points in a route (as long as capacity in the truck can allow it), the more efficient that route is, on average. Route density results in two benefits, lower fuel expense and higher revenues/route.
And ancillary services to uniform rentals are provided to customers because (1) the cross-selling opportunity is there and (2) not all routes can be serviced by trucks at 100% capacity utilization. Cintas (as well as its competitors) provide mats, mops and towels rental programs, restroom supplies, cleaning chemicals, first aid supplies, etc. to their customers. The company also provides fire inspection services and offers training like CPR and first aid. These ancillary products and services make up 15%-16% of revenues.
The company also sells uniforms directly to customers. These customers are likely not contracted with Cintas under a uniform rental program because Cintas provides the uniforms under a typical agreement. This segment has the most volatility and competition is much more broad, with some of the largest competitors being Amazon and Walmart. Cintas considers this segment as an opportunity to sell uniform rental programs to customers. This segment typically makes up 4%-5% of revenues.
Competition in the uniform rentals and services segment is local, which means there is industry fragmentation (over 600 competitors in the U.S. and Canada). There are different ways to count market size and share, but Cintas commands a 3x lead over its top two competitors, Aramark and UniFirst. Just counting the uniform rentals business, Cintas commands ~40% share vs. 14% for Aramark and 12% for UniFirst. When adding in uniform direct sales, the shares go down to 14% for Cintas vs. 5% for Aramark and 4% for UniFirst.
Cintas has outgrown the industry organically since the great recession. Part of that can be explained by superior execution, having greater exposure to larger accounts, and more successfully cross-selling the company’s products and services. Aramark’s uniform division is the smallest for the company, so it seems that it gets overlooked in terms of attention/capital allocation.
The company also expanded operating margins at higher increases than the competition. This can be explained by operating leverage as its two largest segments increase in scale, and increasing route density, especially since the G&K services acquisition. While there is no formal guidance on LT margins, the company has indicated that incremental operating margins usually run in the 20%-30% range. This is higher than fiscal 2020’s margins of 16.4% and fiscal 2021’s margins of 19.5% as the company is still growing in many of its regions that it services. Increasing route density around processing plants/branches lead to healthy operating leverage in the core uniform rentals business.
Why is it a good business?
As the largest uniform rental company, Cintas benefits from scale advantages. The company benefits at both the local and company levels. At the local level, the direct cost advantages to route density (higher capacity utilization of the fleet + lower fuel costs per stop) lead to increasing margins. There is natural leverage of the high fixed costs at a local processing plant, which includes laundry machines, systems, etc.
At the company level, Cintas benefits in three ways. First, the company is able to get better economics for the procurement of uniforms and other items like cleaning supplies, first aid and safety products. Cintas has good working relationships with apparel companies like Carhartt, to provide higher quality workwear for its customers.
Second, Cintas also has the opportunity to pursue many more national accounts because the company has a presence in most of the major cities in the U.S. and Canada. National accounts have much better retention rates. For UniFirst, national accounts have 99% retention vs. the company average of 91%. This is likely because national accounts are less likely to churn based on small changes in price (as long as the service provided in up to par) and less likely to go out of business vs. an SMB.
Third, Cintas is able to cross-sell many of its other services and products to its existing customers. Cross sell is important because customers that adopt multiple services from Cintas are much less likely to churn and incremental services and products within the same route leads to very accretive gross margins.
Cintas’ scale advantages are evidenced by the company’s much higher revenue/facility and operating profit/employee vs. its two main competitors, Aramark and UniFirst. This results in superior operating margins for the company. In 2019, Cintas had operating margins 1.5x that of UniFirst and 1.7x that of Aramark’s uniforms division.
Retention rates at Cintas are higher as well. The company consistently has retention rates above 95%, vs. 91% for UniFirst and 92%-93% for Aramark’s uniforms division. Similar to SaaS companies, retention rates are important because the company has to sell to fewer new customers to maintain the same revenue levels as the previous year. These retention rates imply that the average customer is with Cintas for 20+ years vs. over 10+ years for UniFirst. Part of the difference can be explained by Cintas having a larger % of its customers as national accounts. National Accounts make up 20%-25% of Cintas’ customer base vs. 15%-20% for UniFirst. We note that Aramark’s national accounts make up is difficult to determine because the uniforms division has overlapping contracts with its other larger divisions.
Returns on incremental capital?
Over the past 10 years, Cintas has spent 45% of its capital on capex and 55% on acquisitions, offset by sale of assets. The company estimates that 60% of capex is for growth and 40% is for maintenance in an average year. Within the business segments, the company spends 75%-80% of capex in its Uniform Rental and Facilities Services segment, 15%-20% in the First Aid and Safety Services segment and 5%-10% for its Fire Protection and Uniform Direct sales segment.
Compared to the revenue breakdown of these segments, the capex spend percentages are of a similar range, with the most capital intensive being the First Aid and Safety Services segment and the least Uniform and Direct Sales. The pre-tax return on assets are very similar across the segments in the 14%-18% range. We do note that ROA isn’t the best metric to measure efficiency since the company is acquisitive across its segments. With the write-up of acquired assets, ROAs can understate the return profiles of acquisitions.
Cintas’ capital allocation priorities are to first reinvest back into the business. This means new rental processing facilities and first aid/safety facilities, as well as distribution centers and its fleet of trucks. It typically costs $15M-$20M to build a new plant, which is necessary as a region’s existing facility gets closer to reaching full capacity. The second priority is M&A, which includes small tuck-ins and large deals like G&K Services. The last priority is dividends and buybacks.
On the acquisition front, Cintas made a very meaningful acquisition in 2016 of G&K Services. At the time, G&K was the #4 player in uniform services, generating $1B in revenues from 170k customers in North America. G&K was acquired for $2.1B at a multiple of 13x EV/EBITDA pre-synergies. Cintas identified cost + revenue synergies of $130M-$140M over four years, implying a multiple close to 7x EV/EBITDA or 14% return on capital. Most of the synergies were on the cost side like increasing production and route efficiency, leveraging G&A expenses and better sourcing on the Cintas platform.
The integration process took a long time because of the size of the acquisition and Cintas’ ongoing migration to SAP from inhouse software at the time. The company had to re-catalog every garment and product line, as well as re-optimize routes and account for new capacity vs. planned builds of new plants. As the integration efforts neared the end, Cintas was able to increase capacity in many of its markets, thereby delaying some planned investments (remember that a processing plant costs $15M-$20M). By the end of fiscal 2018, 148 G&K locations were converted to Cintas operations, 63 were closed down due to redundancy and 1.5k trucks were converted and rebranded as part of the Cintas fleet. By the end of fiscal 2019, Cintas realized $100M in synergies and reached the target of $130M-$140M a year ahead of schedule in fiscal 2020.
Cintas’ other meaningful acquisition was Zee Medical in 2015. Zee Medical expanded Cintas’ First Aid and Safety segment, giving Cintas much better scale in sourcing products and distribution. Cintas also hired dedicated sales professionals for the segment, something that Zee Medical didn’t have previously.
We estimate that Cintas generated returns on incremental capital between 20%-35% for the past 4 fiscal years. Because the company exited the document management services business (sale of Shred-It JV to Stericycle in fiscal 2016 and sale of Document Storage in fiscal 2015), the return calculations get a little difficult to calculate in those years. Also, because Cintas’ fiscal year ends in May, the impact from the initial Covid related lockdowns are in fiscal 2020 and fiscal 2021, while the recovery is mostly in fiscal 2021 and fiscal 2022.
Reinvestment potential?
Cintas’ TAM can be analyzed in a few different ways. It’s estimated that the core uniform rental segment has a TAM of $15B-$16B. Cintas commands almost 40% market share, while its two largest competitors command 12%-14% each. Adding in direct sales of uniforms, the TAM increases to over $40B, but it’s not as meaningful because it’s not Cintas’ core business and the segment’s main purpose is for cross selling into a uniform rental program.
We can also look at the TAM by the number of customers. Cintas has over 1M customers and the company estimates that there are another 15M businesses in the U.S. that could benefit from a uniform rental program. Every year, the company gains new customers that didn’t previously have a uniform rental program in place. These are greenfield wins of customers that Cintas calls no-programmers. The company estimates that 60% of growth comes from these no-programmers and 40% of growth comes from competitive wins.
Then when considering the ancillary products and services within the facilities, first aid and fire protection categories, Cintas’ TAM gets bigger. The company estimates that both its first aid and fire protection segments can reach $1B in revenues. Cintas is not that far off from this target and considering the cross selling opportunity that remains, it shouldn’t be too long before those targets are reached. Cintas estimates that of the uniform rental program customer base, the penetration rate for its other products and services are less than 20% on average (with the exception of mats). And only 10% of customers subscribe to two or more services from Cintas.
From an acquisition perspective, the company has the scale and capital to continue to do future tuck-in acquisitions. While it may be difficult from a regulatory perspective to acquire the other large public players, there are many smaller private competitors that have meaningful market share in different cities across North America. And there are hundreds of these smaller competitors that have less than 100 employees.
The company (and analysts) has been more vocal about the healthcare opportunity that exists today because of the impact from Covid. Healthcare customers make up ~7% of Cintas’ revenues, but are 17% of U.S. GDP. Since Covid has instilled better hygiene practices at many healthcare facilities, these businesses are looking to outsource to companies like Cintas for scrub rentals.
The TRSA estimates that 64% of hospital works and 44% of healthcare professional launder their scrubs at home, where there is a higher risk of not washing the pathogens off of the scrubs. The TRSA also estimates that 30% of employees aren’t laundering their scrubs daily, which leads to contamination risk. Similar to other industries, Cintas provides the sourcing, sizing, management and laundering of scrubs at economics that make sense. The company estimates that there is ample room to cross-sell into this vertical as well, for PPE, hygiene products, sanitizer, fire protection, etc.
With a reinvestment rate between 50%-60% and a return on incremental capital between 20%-35%, we estimate that Cintas has increased its intrinsic value between 12%-18% over the past 4 years. While the reinvestment rates can be lumpy when large deals are done, it’s rare to see deals the size of G&K Services. For the most part, acquisitions will likely be small, tuck-ins going forward, which makes the reinvestment rate smoother than other acquisitive companies.
What else is important?
Correlation to unemployment
One thing to consider is that Cintas’s fundamentals are highly correlated to the rise/fall of the U.S. unemployment rate. Customers are often slow to make changes in their rental programs, which means there is often a lag in the fundamentals when there is a recession. Looking at 2008/2009, Cintas’ organic growth rates didn’t decline until 2009 (though the stock price obviously reacts before then). In a higher unemployment period, fewer employees mean customers need fewer uniforms for their rental programs. Furthermore, at least on the SMB side, there can be customers that close down permanently.
However, the company’s revenue sources have gotten less cyclical since the great recession. First, the company’s customer mix has gone from 30% services/70% manufacturing to 70%/30%. Second, the mix of revenues coming from uniform rentals in the company’s main segment, has come down over the past decade. Currently roughly half of that segment is directly from uniform rentals and the remainder made up of mats, hygiene products, cleaning solutions, etc. Previously, uniforms made up ~70% of that segment.
Document management services segment?
Cintas once had a document management services business that was offered to customers. The idea was that there could be better route optimization and capacity utilization with this business. This is a similar thesis to Cintas’ current ancillary product lines in fire protection, first aid and facilities services.
Cintas eventually moved the document shredding part of the business into a joint venture with Shred-It in 2014. Cintas owned 42% economic interest in the JV, which was generating $600M in annual revenues. Cintas received a $180M one time dividend for the JV combination. Later that JV was sold to Stericycle in 2015. Cintas received $575M in proceeds from the sale and also received a $113M dividend payment from Shred-It prior to the sale. Since the sale, Stericycle had to write down the Shred-It acquisition.
Optionality
European expansion
While it’s unlikely that Cintas would be able to acquire one of the other large players in the U.S. market for regulatory reasons, the company could eventually make headway into Europe with a meaningful acquisition. Management still views the North American opportunity as very attractive. So, a large acquisition in Europe in the near-term is unlikely, but the probability could be higher in the future.
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Amazing piece. Do you foresee an attractive buying opportunity coming in this economic environment - gas, wage increase, decent likelihood of a stagnant economy in the future, etc. Their stock seems to have done relatively okay YTD. They compete on price so it doesn't seem like they can raise their prices to offset either. Any thoughts on obsolescence risk through technology (perhaps loss of advantage with electric vehicles, maybe self driving trucks in the distant future)?
always enjoy reading your write ups