Cintas (CTAS) Rides On Modest Organic Growth & Tax Benefits

On Apr 3, we issued an updated research report on business services provider, Cintas Corporation (NASDAQ:CTAS) .

Cintas maintains a focused approach for steady top-line growth. Revenues have been witnessing an increasing trend over the past few quarters. From 2010-2017, revenues of the company have recorded a compounded annual growth rate of 5.2%. Third-quarter fiscal 2018 revenues increased 26.6% year over year to $1,589.1 million while organic growth improved 7.8%.

Cintas aims to continually achieve revenue build-up by increasing penetration levels at existing customers and broadening the customer base to include fresh business segments. Cintas also identifies additional product and service opportunities for its current and future customers to expand its portfolio.

The successful integration of G&K Services Inc. is further likely to expand Cintas’ customer profile and augment its revenues. The combined company is likely to cater to more than 1 billion customers with an extended product portfolio and additional processing capacity. Customer service is also likely to improve with increased route density. The synergies from the combined operations are expected to yield $130 million to $140 million in cost savings from the fourth year of its operation. The transaction is anticipated to be accretive to Cintas’ future earnings.

In addition, Cintas has a strong balance sheet with adequate liquidity to meet its working capital requirements. Over the years, the company has consistently returned significant cash to its shareholders through dividends and share repurchases. Its investment strategy takes a holistic view of the rapidly evolving market and deploys a dynamic capital allocation approach to focus on the relative value of the various sectors within the broader industry. Cintas has outperformed the industry with an average return of 3.9% in the last three months compared with a gain of 3.4% for the latter.

At the same time, Cintas continues to benefit from the U.S. tax reform and provided bullish guidance for fourth-quarter fiscal 2018. Revenues are projected to be $1,625-$1,645 million. Earnings from continuing operations are expected to be between $1.64 and $1.69 per share. This assumes a fiscal fourth-quarter tax rate of 24%.

However, Cintas procures raw materials from a wide variety of domestic and international suppliers, making it susceptible to market risks which are beyond its control. A continuous increase in raw material costs such as cotton also weighs on its margins. Cintas faces stiff competition from national, regional and local companies on various factors such as design, price, quality, service and convenience to the customers. Specifically, its first aid and fire protection services are decidedly commoditized markets and hence are subject to fierce competition. As such, the company has to continually invest in value drivers to fend off competition, which further weakens its profitability. Moreover, some customers have started to perform certain in-house services themselves instead of outsourcing them to Cintas. This resulted in some loss of businesses.

Nevertheless, we remain impressed with the inherent growth potential of this Zacks Rank #3 (Hold) stock. Some better-ranked stocks in the broader industry are Applied Industrial Technologies, Inc. (NYSE:AIT) , Dover Corporation (NYSE:DOV) and EnPro Industries, Inc. (NYSE:NPO) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Applied Industrial Technologies has a long-term earnings growth expectation of 12%. It topped estimates in each of the trailing four quarters with an average positive earnings surprise of 11%.

Dover Corporation has a long-term earnings growth expectation of 13%. It topped estimates in each of the trailing four quarters with an average positive earnings surprise of 7.3%.

EnPro Industries has a long-term earnings growth expectation of 22.3%.

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