The labor market data has been robust and fueling business for employment services, retail, and consumer products. The non-farm payrolls data for September came in a bit weak at the headline level but every other data point within the report points to one thing - improving labor market conditions for employees and guaranteed business for Cintas (NASDAQ:CTAS).
The Labor Market Is Robust
August Non-farm payrolls rose a tepid 134,000 but that number is mitigated by many factors and nearly meaningless. For one thing, it is the difference between two estimates (the estimated number of job gains and the estimated number of job losses), both of which get revised twice. For another, the margin error is often great enough to cancel out any job gains. When you add in the revisions to the previous two months, July and August, the headline figure increases to 221,000 and is well above average and expectation.
The more important figure is the twelve-month average which is 201,000. The US labor market has been adding more than 200,000 jobs per year for more than two years and that has led to record unemployment. Unemployment now stands at 3.7% and likely to move lower if the number of open jobs is any indication. The JOLTs report says there are over 5 million job openings in America right now, almost enough to bring the unemployment rate to zero.
Along with the drop in unemployment was another noteworthy increase in average hourly earnings. Average hourly earnings rose $0.08 or 0.3% over the past month and are up 2.8% from the same month last year. These gains are icing on the cake for Cintas as they will drive consumer spending on all levels and add fuel to economic expansion.
Cintas Is The Leading Employment Services Company
Cintas is by far the best investment in the employment services space. It is the leading supplier of employment services delivering uniforms, workplace supplies, first-aid, and safety equipment to businesses across America.
The company has been growing revenue organically and through acquisition for nearly 20 years and is projecting continued growth over the next fiscal year. The business is solvent and pays one of the safest dividends on the market with a payout ratio near 22.5%.
The stock recently underwent an earnings-driven correction and that is an opportunity for me to increase my holdings, and for new investors to get in at a discount. The fiscal first quarter report was perfect except for one thing: everything in it was expected and no wonder, the company is well managed and has been delivering results for a long time.
Revenue for the fiscal quarter 5% net, 5.2% organically, and 4.9% for the core uniform and facility services business. The first aid and safety business grew revenue by 9.0%. Organic, core uniform and facility sales would have been stronger if not for the overlap with G&K Services.
G&K Services is a recent acquisition for Cintas that is expected to be fully integrated by the end of the fiscal year. Excluding charges related to the G&K acquisition operating income was up 12% from the previous year. Organic growth rates are expected to pick up and strengthen through the end of fiscal 2019 as the G&K integration reaches its conclusion.
One of the benefits of the G&K acquisition and the acquisition of Zee a few years ago are cost synergies that have margins on the rise. The Zee acquisition allowed them to combine routes where Zee (medical and first aid) and Cintas (uniforms, services) overlapped and provided inroads to new businesses where they did not, and those same synergies are in play with the G&K.
Excluding non-recurring costs related to the G&K merger, margins are up a full percent in the fiscal first quarter as those synergies bear fruit. As it is, the company was still able to increase margins by 16 basis points and deliver EPS $0.13 above the consensus estimate of $1.80.
we continue to experience the inefficiencies that are customary with an acquisition integration and an ERP system implementation and these activities weigh on margins in the short-term. With all that being said though, we were pleased with the gross margin expansion on a sequential basis
Cintas also made an improvement to its already solid balance sheet. The company paid down about $300 million in debt resulting in $6 million worth of savings in interest charges. This improvement helped boost net-income from continuing operations by 31.9%.
The company also increased its previously stated forward guidance for 2019 and to a range above consensus. The new guidance is $6.80 to $6.86 billion, up from $6.75 to $6.82 billion, with full-year EPS expected to be $7.19 to $7.29. The new EPS range is $0.04 above the previous range of $7.00 to $7.15 and evidence of improving margin.
There Are Still Risks For Cintas
Cintas is in a great position to continue growing along with the labor market. Even so, there are still risks to that growth including wage inflation, the trade war, and rising energy costs. The good news is that management at Cintas is well aware of the issues. The company's VP, Paul Adler, had this to say on the conference call:
We were starting to see cost pressures in a few areas. Energy expense was a headwind of about 20 basis points. We are experiencing wage inflation in certain areas and we’ve seen some cost pressures on our hangers, which largely are sourced from China. Keep in mind, that all of these are considered in our updated guidance.
Another risk is the growing possibility of a recession in America. I know it sounds crazy that an economy growing as robustly as the US could face recession but it's true, but not for reasons you think. The crisis in America today is a growing lack of employees. Labor markets are getting tighter every week and every month, as they tighten, there will be fewer and fewer available bodies to fill the 5 million jobs currently available, and that may lead some businesses to shut their doors.
Regarding competition, Cintas has very little direct competition except local and regional operators. There are no direct comparisons among publicly traded companies that match the size, scope and business of Cintas. The closest may be Aramark (ARMK), which provides uniform and facility services, but also manages, staffs and operates those facilities. Automated Data Processing (ADP) is another pure play on the employee but offers no competition for Cintas.
My Conclusion Is This, Cintas Is Still A Buy
While it is understandable a stock would sell off on news as-expected, I view the dip in Cintas as a buying opportunity. In addition to healthy labor markets and organic growth, the stock has other qualities investors will like, namely its Dividend Aristocrat Status.
Cintas has increased its dividend every year for the last 26 years. The five-year dividend growth rate is over 20% which means this year we can expect to see the distribution increased by more than $0.30 per share.
Cintas is expected to announce an increase to its dividend later this month or early next month, as it does every year, and that will drive new demand for this play.
The stock tends to trade with a yield near 1.0% which isn't great but there is a trade-off. Shares prices have been steadily rising for decades, driven by capital growth and dividend growth. The five and ten-year yield-on-cost ratio of 3.17% and 7.35% shows that shares prices have been steadily rising along with the dividend increases.
The best part is that with the payout ratio so low (about 23%) Cintas could sustain dividend increases for many years in a stagnant or declining labor market, just like it did through the 2008 Financial Crisis, before adversely affecting free cash flow.
Is Cintas a buy? Only if you want a stable, growing dividend paid by a financially sound business supported by economic growth trends. Cintas may not pay the highest dividend in the market but it is one of the safest and comes with capital growth to boot.
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.