Investment thesis

Cinta (NASDAQ: CTAS) is one of those companies that you buy in the hope that their revenue will grow enough for your investment to make sense. Here are the returns based on the current share price:

• EPS/Price: 2.9% FCF/Price: 3.0%

Would you buy a company producing these returns if it was not publicly traded? I do not think so. Interest rates are rising and you will soon get better returns by buying Treasury bills.

Some cite revenue growth as a factor in buying CTAS. Every investor has their own required rate of return on the investments they buy, and I know people in the private equity industry who wouldn’t touch a company if it didn’t return at least 20% every year. The national average for cap rates on a two-bedroom apartment is 5%, reflecting a more moderate investor base. Let’s say you’re comfortable with an 8% annual return on your money and you’ve purchased all CTAS shares at the current price of $390 per share. To achieve your required 8% ROI, which in this case is $41 billion, CTAS needs to triple its net income from current levels. Only then will you begin to receive your 8% ROI rate. So far, it’s just disappointing low to mid-digit returns.

The company’s record growth cannot be ignored, but I think investors are paying too much for it. Over the past four years, average annual EPS growth has been 10%, supported by organic growth, share buybacks, price increases and mergers and acquisitions. Applying this growth rate to the current level of earnings means that an investor would have to wait eleven years to start earning the 8% return on investment mentioned above.

Our holding rating reflects CTAS’ strong market position, track record of growth and strong balance sheet, backed by long-term contracts and management expertise, offset by strong price multiples.

Revenue Trends

From a strictly financial standpoint, in some cases it makes sense for a business to lease consumables for their lifetime if the price is right. CTAS has been in business for decades, verifying the sustainability of its business model, and it’s clear its customers find value in outsourcing non-essential operations, from cleaning uniforms and towels to restocking hand soap. .

CTAS’ scale allows it to offer low prices, creating a competitive moat against market entrants. The business is profitable and finds new ways to increase revenue. In the last quarter, organic growth was 10%, supported by several factors.

1. Price increases of CPI indexations in its rental contracts
2. Market share expansion
3. Presentation of new products

M&A mergers and acquisitions contributed 0.3% to revenue growth.

The company’s historic growth figures are cause for optimism. It recently adopted a new “CRM” customer relationship management system from SAP (SAP), equipping its sales force with an advanced digital arsenal to improve sales. A rebound in the hospitality sector as governments ease social distancing rules provides another tailwind for growth.

I think CTAS will continue to grow in the coming quarters. My main concern is with evaluation. As mentioned above, CTAS needs to triple its net income to start making sense as an investment at current prices. The question is, are these growth factors enough to get us to this level, and if so, how long should we wait?

Evaluation

As of this writing, CTAS is trading at $390 per share, down 3.7% over the past five days. I believe there is even more downside potential, given its high valuation.

The stock trades at 37x PE, almost double the industry sector median, and its EV/Sales is more than triple the sector average. These ratios are reflected in Seeking Alpha’s quantitative scores, rating CTAS an F on valuation.

For CTAS to trade in line with the peer average, the price would need to drop 50% to $200 per share. Even if CTAS maintained 10% revenue growth, it would take seven years to reach the average of its peers.

CTAS stocks have snowballed over the past five years, outperforming the index. However, this comes at the expense of higher price multiples than earnings growth. Below is a graph showing the PE ratio over the years.

Financial situation

I mentioned mergers and acquisitions as one of the potential drivers of revenue growth. The financial solidity of the CTAS offers it this possibility. Total interest-bearing debt is $2.8 billion, compared to $8 billion in assets. The annual interest rate is $90 million, offset by an EBIT of $1.4 billion.

Financially stable companies often hold debt, taking advantage of the return on equity “ROI”. Last week, CTAS issued $1.2 billion in new notes to refinance recently matured $1.2 notes. The company found itself borrowing at slightly higher interest rates. Below is the company’s debt schedule.

Value millions	Coupon	Maturity	Price	Effective yield
$300.00	3.25%	June 22	$99.41	9.46%
$400.00	3.45%	25-May	$99.54	3.47%
$1,000.00	3.70%	April 27	$98.95	3.94%
$800.00	4.00%	May-32	$98.44	4.06%
$250.00	6.15%	Aug-36	$120.59	4.22%

Source: Morning Star

Did you notice the effective yield of 9.46% on the $300 million 3.25% notes due next month (June 2022)? This has more to do with the recent market disruptions and illiquidity in the note market than with CTAS credit fundamentals.

Dividend

CTAS benefits from a stable dividend payout policy, supported by a low payout ratio and strong FCF. The company has been increasing its dividend for over thirty-six years, earning it a position among the dividend aristocrats. However, its yield, which currently stands at 0.96%, is below par.

I expect gradual but steady dividend increases, despite market turmoil.

Summary

The stock market is expensive these days and I think the market sell-off will continue as the Fed raises interest rates. Soon it will become more economically feasible to invest in bonds rather than inflated stocks. There are still a few good deals out there, but CTAS isn’t one of them.

Even if CTAS grew by 10% per year, it would be years before its profits were large enough to justify its current price. The implied required rate of return is minimal at current levels. Our holding rating reflects the company’s growth record, dividend growth, scalable operations and competitive moat, weighted by a high valuation.