Clean Up With Uniform Rental Companies

Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Investors’ eyes are all seemingly fixed on the fiscal cliff negotiations in Washington and its impact on our economy going into 2013.  So while there’s plenty of dirty laundry flying around our nation’s capital, investors should turn their attention to the clean laundry being provided by uniform rental companies.  

As this recent article points out, paying attention to uniform rental companies is a compelling way to monitor employee hiring trends in manufacturing, automotive, hospitality, and the other sectors served by the industry. Reading this news story prompted me to revisit my earlier post on the uniform rental companies including UniFirst (NYSE: UNF), G&K Services (NASDAQ: GK), and industry giant Cintas (NASDAQ: CTAS).

In my earlier post, I concluded that “I would consider purchasing shares (of Cintas) if the PEG (price to earnings to growth) multiple shrinks due to price underperformance or raised earnings expectations.”  So what has happened since then?  Cintas’ shares have barely budged from when they traded at around $41, closing at $42.01 on Dec. 10.  The 2014 PEG multiple is now at 1.5x, which expanded from the previous 1.4x multiple due to slightly lower expected EPS growth and a slightly higher forward PE ratio.  Specifically, the PE ratio increased 2.0% to 15.0x from 14.7x previously.  

Additionally, forward EPS growth is now estimated at 9.8%, which is down from 10.3%.  This decline in estimated growth for 2014 is due to an increase in the consensus 2013 EPS estimate (to $2.55), while the 2014 consensus estimate is unchanged at $2.80. So while increased 2013 EPS is certainly positive, my earlier thesis has not materialized and I remain a holder rather than a buyer of Cintas shares.

At around $1.4 billion, UniFirst is the second biggest uniform provider by market capitalization (Cintas is at $5.2 billion), and has seen its shares rise by about 5% since the previous post.  The company carries a PEG multiple that has shrunk to 1.6x from 1.8x as the consensus 2014 EPS growth estimate has risen to 8.3%.  This contraction in the PEG multiple in the face of rising shares is bullish and was bolstered by the company guidance rising throughout the year.  From its initial guidance in October 2011 of $3.65-$3.95 per share, the company raised its 2012 guidance every quarter, ultimately to $4.60-$4.70 in June before the actual 2012 EPS came in at $4.76, fully 30% above its initial guidance for the year.

Most recently with the 4th quarter 2012 earnings release in October, the company guided 2013 EPS to a range of $4.65-$4.85.  In response, the analysts’ consensus 2013 EPS estimate was raised $0.02 to $4.82 and the 2014 EPS estimate was raised $0.03 to $5.22.  The current PEG multiple at 1.6x is on the high side for my conservative investment style, but the combination of PEG shrinkage (despite the higher share price) and the repeatedly raised EPS guidance are appealing enough to place it as a candidate to watch.

Finally, G&K Services has seen its shares remain essentially flat.  Like Cintas, G&K has seen its PEG multiple expand despite a weak share price because its expected growth rate has declined to under 13% compared to almost 16% previously.  However, like UniFirst, the company raised its guidance in October with 2013 EPS guided to a range of $2.25-$2.45, or more than 2% above the $2.20-$2.40 range guided in the previous quarter.  Also like UniFirst, consensus EPS estimates have been increased for 2013 to $2.43 from $2.36 previously, and for 2014 to $2.74 from $2.72 previously.  The PEG multiple of just 1.0x is easily the lowest of the group, and in conjunction with rising EPS estimates makes G&K’s shares very attractive.

PEG analysis is useful for establishing the relative attractiveness of these companies but further considerations are needed to decide on a long term stock holding.  For long term holdings, being the best of breed in an industry matters more than PEG at a single moment and Cintas is the clear leader with its dominant scale, superior margins, and leading cash flow capability.

Because of its competitive advantages such as economies of scale and greater leverage over suppliers than its rivals, Cintas has achieved gross and operating margins that have averaged 42% and 13%, respectively, compared to 38% and 11% or less, respectively, for its competitors since 2007.  Also, free cash flow has averaged about 8.5% of revenue since 2007 compared to less than 7% for its competitors. Cintas has experienced declining return on invested capital (ROIC) over the past 10 years as it broadens its operations into faster growing but more commoditized and unrelated segments like direct uniform sales, fire & safety services, and document management.  Consequently its ROIC at a recent 8.9% still towers over G&K at 4.4% but now trails UniFirst which has improved its ROIC to a recent 9.9%.  

Despite this closing of the ROIC gap by UniFirst, Cintas is still in a better operating leverage position due to its scale.  When normalized economic growth eventually resumes, I believe Cintas will again produce industry leading ROIC because it will be able to capture more market share than its smaller rivals in the highly fragmented core uniform rental business and will better manage volatile fuel, labor, and apparel fiber costs over its larger asset base.

By providing fresh uniforms for employees of manufacturing, healthcare, retail, automotive, and hospitality businesses that serve the rest of the U.S. economy, the uniform rental companies provide a check of the employment picture for the whole economy.  So as the fiscal cliff draws near, don’t just watch the dirty laundry flying around the bickering parties in Washington, take a look at the companies who are cleaning the laundry for main street.

56Steve has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Cintas. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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