Cintas: A Great Company Facing A Huge Problem

| About: Cintas Corporation (CTAS)

By Jeff Bailey

There's something remarkable about a prosaic business, say rental uniforms, run with such insane rigor and precision that it becomes a great company, and Cintas (NASDAQ:CTAS) is surely one.

Dick Farmer, possessing a healthy streak of OCD, applied time-and-motion studies to the rag-rental business his grandfather had started around Cincinnati, and somehow managed to reduce his workforce and take on more customers at the same time. That was 1960 and Farmer, 25 at the time, was emboldened by his immediate success. He quickly diversified into uniform rental, acquired competitors and turned Cintas into the industry's dominant company.

Cintas today has 900,000 customers, 30,000 workers (you've seen its white vans driving all over the place) and is run by Dick Farmer's son, Scott Farmer, who by all accounts is a chip off the old block. The term "hard work" appears in Cintas press releases. For investors, following a 1983 IPO, the returns have been amazing, as seen in a stock chart.

CTAS Chart
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CTAS data by YCharts

We should forgive Cintas shares for peaking during a period beginning in the late-1990s, as that was due mostly to a temporarily nutty valuation the company attained, its PE ratio nearing 60 at one point. With its odd name, maybe someone thought it was an Internet startup, eh?

CTAS PE Ratio TTM Chart
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CTAS PE Ratio TTM data by YCharts

The company's finances have been run with a rigor equal to its operations. Shares outstanding have plunged as the Farmers, substantial shareholders themselves, used Cintas' hefty cash flow to buy back huge amounts of stock.

CTAS Shares Outstanding Chart
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CTAS Shares Outstanding data by YCharts

So, modest revenue growth, coupled with intense cost control (the Farmers have run off union organizers with particular zeal and collected labor-related litigation along the way), has produced better-than-modest growth in net income. And the decline in shares outstanding has nicely goosed EPS.

CTAS Net Income Quarterly Chart
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CTAS Net Income Quarterly data by YCharts

As the economy gets moving following a recession, and employers start hiring again, Cintas has typically thrived. And it's recovering nicely just now, having reported fiscal 2013 results, for the year ended May 31, earlier this week: revenue up 5.2%, net income up 6% and EPS up 11%. More of the same is expected for the fiscal year just beginning.

So what's with the discouraging headline on this article? Well, Cintas is one of a number of well-run companies that is dependent on employment levels rising. And as we noted in a recent article on the prospects at Automated Data Processing ((NASDAQ:ADP)), the payroll processor, employers in the U.S. resist hiring workers with all their might, and that has given us economic recoveries that are increasingly jobless.

Each recession, companies learn how to be more productive, and they make do with relatively fewer workers going forward. It's an incredible productivity story, though one that has left millions of lower-skilled workers behind.

US Employment Chart
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US Employment data by YCharts

Yes, Cintas' customers are heavily concentrated in the service sector, and outsourcing the work to China isn't an option. But productivity among service providers has risen, too, and the growth of uniform-wearing workers, it would seem, can be expected to slow going forward. That doesn't make Cintas a crummy company - far from it. But its industry could trend toward to crummy. And over time that could mean a lower valuation.

So, while Cintas can be expected to perform nicely as this recovery progresses - and its many fans in the investment world will likely bid of its shares accordingly - long-term investors may want to proceed with caution.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.