Share prices of Cintas (CTAS 3.52%) are up roughly 28% from where they started 2020, before the COVID-19 outbreak spread into a full global pandemic. For those who have been shareholders that entire time, that's a strong return on investment. But for investors considering buying in now, there's a small problem here that should not be overlooked.
The ups and downs of Cintas' business
Cintas has two main lines of business. Its service providing uniforms to businesses makes up around 80% of its top line. Most of the rest comes from its facility services segment, which includes first aid and safety services. (That growing niche now accounts for a little more than 10% of total revenue.) Over the past year or so, due to the coronavirus pandemic, the first aid and safety services division has been doing extremely well. Organic revenue in this segment was up by nearly 18% in its fiscal 2021 third quarter, which ended Feb. 28.
During a bad time for the world's health, Cintas' first aid and safety business has definitely been a bright spot. But it's such a small part of the company's overall business that it really wasn't enough to change the bigger picture. Cintas' business is normally highly cyclical, with its uniform division waxing and waning along with the broader economy. And that business took a big hit last year.
In the quarter before the pandemic hit -- Cintas' fiscal Q3 2020 -- the company's overall sales rose by 7.6%, with organic sales in the uniform segment up 4.8% and first aid and safety up 12.5%. During the initial stages of the pandemic, when economies around the world were shut down, revenues declined 9.7%, with uniform segment organic sales dropping 9.6% and first aid sales up 21.9%. The growth pick-up from the health side of the business wasn't enough to offset the hit taken by the much larger uniform business.
However, revenue from the uniform segment gradually got better over the next three quarters, with year-over-year declines coming in at 5.4%, 3.6%, and 2%, sequentially. This improving trend is nice to see, but the headwinds clearly persist. So while sales in the first aid and safety division have remained solid, with organic growth of 14.5%, 16%, about 18% sequentially, Cintas' overall revenues in the first three quarters of its fiscal 2021 dropped 3.6%, 4.5%, and 1.7% sequentially.
A mixed picture for Cintas
Looking strictly at revenue, Cintas still appears to be muddling through a bad period. However, management's cost-containment efforts over the last three quarters have allowed earnings to remain quite strong. They were up nearly 20% year over year in the first quarter of its fiscal 2021, 15% in the second, and 9.7% in the third. While that's very good news, and fairly impressive, it doesn't alter the fact that the company is still facing headwinds in its most important business.
And yet the stock is trading nearly 30% above where it was prior to the pandemic. That translates into a price-to-sales ratio of nearly 5.4, compared to its five-year average of 3.4. Sales tend to be more consistent over time than earnings, so this is a sign that investors are materially overvaluing the stock today given the business backdrop.
That said, investors could easily argue that the earnings picture is much brighter than the sales picture. That's true, but the price-to-earnings ratio is similarly inflated, at roughly 38 compared to a longer-term average of 30. Even if you look to the future using Cintas' price-to-forward-earnings ratio of 34, that's notably above the five-year average of 29.
Caution is in order
Cintas stock is trading near all-time highs and at valuations that are above recent historical averages. While it's doing well on the earnings side of things as it navigates through a difficult market, its main business, uniforms, continues to struggle in the face of the pandemic. The company is about to lap the most difficult period of the pandemic, but it's important to note that its sales are only just clawing their way back to pre-pandemic levels, assuming the outlook that management provided on Cintas' fiscal third-quarter 2021 conference call proves accurate. Conservative investors and those with a value bias will probably want to watch this stock from the sidelines for now. Cintas is a well-run company, but Wall Street seems to be pricing in a lot of anticipated good news right now.