Here's Why I'm Holding Onto Cintas

Summary

• Cintas provides services that add brand value to its clients.
• Cintas’s employee retention and training attitude translated into excellent fundamentals for the company.
• Cintas reduced long-term debt so far in FY 2015.

Investors become co-owners of dynamic businesses when they buy shares of a publicly traded company. With that said, it is important for investors to understand the businesses in which they are investing. Publicly traded business owners should want their enterprises to sell highly wanted or needed products. It's also good for your business to sit behind high barriers to entry against competitors. Cintas (NASDAQ: NASDAQ:CTAS) represents an example of a company that provides a highly needed service. Let's examine.

What does Cintas do?

Cintas is in the business of selling and renting uniforms and accessories, cleaning supplies and janitorial services, and safety supplies and services. Cintas helps improve the brand of its business clients by keeping their environment clean and professional looking for their customers. Company names on client uniforms helps market the brand of Cintas' clients.

Barriers to entry?

Due to the service nature of the business Cintas' barriers to entry from competitors remain relatively low. Technically, anyone with some financial backing can design a cool company logo, solicit clients and begin selling and renting uniforms and safety supplies and services. However, personal experience has taught me that the need to build solid business relationships and a lack of experience in the business could provide significant hurdles to competitors. Any experienced salesman has heard a prospective client say, "I already have someone for that and I like him/her very well." Unless the competitor can offer a great deal more for each dollar spent, people will generally continue to do business with those who they trust and, quite frankly, like on a personal level.

On that note, Cintas' management asserts that one of the key drivers of sales growth resides in the "increased tenure and improved training" of its sales force. Salespeople who have worked for Cintas over a large number of years better understand the needs and personal quirks of clients, and they know how to respond accordingly. Also, Cintas' training, coupled with experience, makes for an impactful salesforce.

Great fundamentals

Looking under the hood, Cintas sports solid fundamentals. Over the past five years, its revenue, net income and free cash flow increased 26%, 90% and 58%, respectively (see chart below). A combination of organic growth and acquisitions contributed to these increases. Retention of employees obviously pays off for Cintas.

CTAS Revenue (NYSE:TTM) data by YCharts

Cintas possesses an ok balance sheet. In the most recent quarter, the company possessed $200 million in cash, which equated to 11% of stockholder's equity. I like to see companies with cash amounting to 20% or more of stockholder's equity to self-finance operations, acquisitions, dividends, etc. However, in counterbalance Cintas lowered its long-term debt 19% since the end of its last fiscal year. The company's long-term debt amounts to 57% vs 67% at the end of the fiscal year. I like to see companies with long-term debt amounting to 50% or less of stockholder's equity. However, I am impressed to see the company reduce its long-term debt during these times of record low interest rates.

Cintas' excellent fundamentals translated into superior returns for its shareholders. Over the past five years, Cintas owners enjoyed a total return of 256% vs 90% for the S&P 500 (see chart below).

CTAS Total Return Price data by YCharts

Dividends

Cintas pays a dividend and resides on the prestigious Dividend Aristocrat list. On Oct. 14, it announced 32 consecutive annual dividend increases. I like to see companies pay out 50% or less of their free cash flow in dividends retaining the rest for other uses. Last year, even with a special dividend, Cintas only paid out 56% of its free cash flow out in dividends. The year before that the dividend only amounted to 20% of free cash flow. Currently, Cintas pays its shareholders $1.05 per share per year and yields 1.2% annually.

High valuation

Over the past 10 years the company remained overvalued relative to the stock market. Currently, Cintas's P/E ratio resides at a 10 year high of 26 vs. 19 for the S&P 500, according to Morningstar, making it especially overvalued and adding to its market price risk. Interestingly, the S&P 500's P/E also resides at a 10 year high, making Cintas overvalued in a pricey market.

Conclusion

Right now I am a holder and not a buyer of Cintas shares due to its excessive valuation during a pricey market. If you decide to buy shares in the company it may be advisable to buy a small position, while adding more shares during a market downturn. You can expect to collect ever increasing dividends during all of the possible volatility. Finally, Cintas is a great company, but it's pricey.

Analyst’s Disclosure: I am/we are long CTAS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.