Matthew Young: We recently upgraded our moat rating for Cintas (CTAS) to wide from narrow, following a fresh look at the firm's competitive positioning. For background, Cintas rents and sells corporate identity uniforms and related ancillary services (entrance mats, mops, restroom supplies, and so on) to fairly wide array of end markets (retail, manufacturing, hospitality, gaming, and so forth).
The firm is, by far, the leader in the space with a roughly 25% market share. Why the change to a wide moat rating for Cintas? When you boil it down, we believe the firm's core uniform-rental-services business benefits significantly from scale-based cost advantages that should allow for positive economic profit and ROICs in excess of cost of capital over the long run and very likely throughout the business cycle, as we saw in the 2008-09 downturn.
The uniform-rental industry is a route-based business requiring significant network infrastructure. Consider the need for a large fleet of trucks for local pickup and delivery and processing plants for picking up and cleaning garments, distributing products, and so forth.
So, naturally, as a provider scales up in size, it gains incremental leverage over a fairly hefty fixed cost base, especially as route density improves.
Overall, we think Cintas' favorable competitive positioning shows up in its operating performance. Consider its solid ROICs historically and industry-leading operating margins. From a valuation standpoint, however, the shares do currently look a bit expensive--trading at a more than 25% premium to our $67 fair value estimate.