Dirty linen has two meanings for Angelica (NYSE:AGL). First, the company is in the business of textile rental and "linen management services," principally for health-care institutions. Fancy words for taking care of the laundry. Second, the company is having problems with a union that represents workers at 23 of its 35 plants -- and those problems recently escalated into an employee walk-out at one plant, followed by a company lockout that has generated uncomplimentary publicity.

So, is there a good investment in all this dirty linen?

The market
Between hospitals, long-term care facilities, and clinics, health-care linen service is estimated to be a $5.6 billion-a-year market. Angelica's target area only covers half of the U.S., and it had fiscal 2004 revenue of $316 million, leaving plenty of room for growth.

Angelica's sales pitch is simple: Save money by outsourcing your in-house laundry so your valuable health-care real estate can be used for revenue generation.

Given its relatively small size, the company is unable to pursue organic growth via economies of scale, and, as such, is keeping an eye on smaller regional competitors. Accordingly, Angelica's growth strategy is heavily oriented toward acquisitions. The company made 11 purchases, for a total consideration of $106 million, over the 15-month period ending January 2005 -- and more acquisitions are on the way.

First-quarter results
The effect of these acquisitions can be seen in the financial results the company issued after the market closed yesterday. First-quarter revenue was up 32%, and only 4.1% of that growth was organic. The rest was the result of acquisitions.

The earnings news was not as good. Operating income increased at a rate just half of revenue growth -- up 15.9%. Reducing income was a $1.9 million increase in depreciation and amortization expenses (ah, the cost of acquiring assets), plus a jump in natural-gas prices that drove the company from 4.4% of total revenue in the year-ago quarter to 5% this quarter.

The first quarter's gross margin was 15.1%, down from 15.7% for fiscal 2004. The company anticipates fiscal 2005's gross margin will exceed 2004's by the end of the year.

Potentially worrisome are the rising debt and the aforementioned union problem. Short- and long-term debt soared 50% over the year-ago level to $102.6 million, in accordance with the company's acquisition strategy. (Angelica used debt to finance the aforementioned acquisition activity.) But the debt will be of no concern if the company's acquisitions pay off in the form of future higher gross and operating income/margins that will enable it to comfortably service its debt. Interest coverage (earnings before interest and taxes over interest expense) declined from 6.18 times last year to 1.75 times currently, a potentially troubling development. The union problems, although worrisome, will eventually work themselves out.

Competition and outlook
The competition includes Aramark (NYSE:RMK), which sells a bundle of services, including laundry, to health-care facilities. There are also other large companies with subsidiaries in this business -- and many small, local service providers.

Analysts expect Angelica to earn $0.88 a share this fiscal year (ending January 2006) and $1.76 the following fiscal year -- pricing the stock at a reasonable 15.1 times forward earnings. So the earnings outlook for dirty linen is bright.

Angelica has restructured to become a "pure play" player in linen management and is working to reach gross margins of 20%, according to the conference call. Also worthy of consideration: The U.S. Census estimates the population over 65 will double over the next 25 years. The American Hospital Association estimates that people over 65 use hospital services at a rate three times that of the general population. The mega-trend is in favor of dirty linen and Angelica, but the real question is whether the company's acquisition strategy will permit its financials to follow.

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Fool contributor W.D. Crotty does not own shares in the companies mentioned. Click here to see the Fool's disclosure policy.