Is Cintas Stock a Buy? | The Motley Fool

Cintas (NASDAQ:CTAS) is about to start growing. According to Wall Street analysts, the company will report year-over-year sales growth of nearly 11% when it reports its fourth-quarter 2021 earnings to May 2021. Of course, it’s coming up against the period when the pandemic hit its business hard in 2020, but growth is still growth.

So will the upcoming earnings report mark the start of a multi-year period of expansion that will make the stock look cheap? Or is Cintas stock overvalued given what’s about to come?

Image source: Getty Images

The investment case for Cintas

The company’s core business is in uniform rental and facility services, which contributed $5.64 billion of the company’s total revenue of $7.09 billion in 2020. It’s a business that took a hit from the COVID-19 pandemic, and it’s not hard to see why: Around 70% of Cintas’ sales traditionally go to service industries, and hospitality and food service are key. Moreover, as facilities were closed, Cintas suffered a drop in demand for uniform rentals.

However, that was then, and this is now. Therefore, the case for buying the stock rests on the following:

  • Cintas’ core service customers will recover over time, and the company’s sales will enjoy a multi-year expansion.
  • The company has a growth opportunity, as the pandemic will raise awareness of the need to ensure cleanliness and health in the workplace.

In a nutshell, it’s a combination of a recovery in end markets and an increase in Cintas’ penetration rate within its end markets. As the company notes, it only does business with 1 million of the 16 million businesses in North America. And given the relative simplicity of the business, it should be easy for Cintas to generate margin expansion as it builds scale. In addition, the company can build on its sales of the first aid and safety services developed during the worst of the pandemic.

How will Cintas grow?

The critical question is whether Cintas will get back to the kind of 7.2% annual revenue growth rate that it boasted in the decade ending in May 2020. It’s not an easy question to answer. CEO Scott Farmer was asked about it during the company’s earnings call in May, and he responded by saying, “That’s tough for us to predict. You know, I’m not sure that I’m going to go out and say that we’re going to be doing better than we were from a percentage growth standpoint, post-pandemic than we were pre-pandemic.” 

A hospitality worker

Image source: Getty Images.

Chief Operating Officer Todd Schneider further defined matters by stating that “the real unknown” is the level of growth from the “additional services that we’ve been able to provide. Here’s what we know is that demand is going to be higher in the future than it was pre-pandemic.” As a reminder, Cintas also sells products like gloves, sanitizers, face shields, etc. Schneider also noted that Cintas hadn’t adjusted its prices for two years, so investors can hope for some revenue growth from price increases in the future.

What it all means for investors

The valuation debate around the stock is expressed in the chart below. As you can see, the forward price to earnings ratio of 33.5 times estimated earnings is similar to the peak reached just before the pandemic hit.

CTAS PE Ratio Chart

Data by YCharts

In other words, the market appears to be pricing in the positive investment case outlined above. That’s fair enough, but it doesn’t leave any room for error if anything goes wrong. There’s no guarantee that hospitality industries (like hotels and catering) will snap back to pre-pandemic levels in a hurry.

Furthermore, it’s worth noting that Cintas sales growth will always depend on employment conditions. There is an underlying growth story from the increase in penetration rates — convincing more businesses to outsource uniform provision — but its sales follow employment growth, and therefore economic growth.

Is Cintas a buy?

On balance, I think the answer is “not at this price.” There’s little room for error in the valuation, which implies limited upside if things go right and substantial downside if things go wrong. As such, it probably makes sense to wait and see how the recovery pans out and whether Cintas really can return to 6%-plus annual revenue growth rates or not in the future.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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