Cintas: Rags to Riches - [Business Breakdowns, EP.173]

0:03This is Business Breakdowns. Business Breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. We believe every business has lessons and secrets that investors and operators can learn from. and we are here to bring them to you. To find more episodes of Breakdowns, check out joincolossus .com. All opinions expressed by hosts and podcast guests are solely their own opinions. Hosts, podcast guests, their employers or affiliates may maintain positions in the securities discussed in this podcast.

0:45This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Today, we are breaking down Cintas Corporation. The company's origins trace back to the depression of the 1920s when the company's founder, Richard Farmer, who at the time was a circus worker, began a small business to reclaim and clean rags for local factories in Cincinnati, Ohio. Nearly 100 years later, Cintas today is set to approach $10 billion in sales at a 10 % five -year CAGR and a 20 % operating margin, putting it solidly in the high -quality bucket and trading at a multiple that's indicative of it.

1:27It is America's largest uniform rental company. For around $1 .50 per worker per day, Cintas will collect, clean, and replace uniforms for organizations in industries such as lodging, hospitality, entertainment, manufacturing, healthcare, and with its business even extending to semiconductor fab bunny suits. It remains a family -owned business with multiple generations of the farmer family having held leadership roles at the company, including CEO and today, the executive chair. To help break down Cintas, I am joined by Delian Enchev, a portfolio manager at Aorus Investment Management. We hope you enjoy this conversation.

2:13Delian, thank you for joining us to break down Cintas. It's a business that I think our audience is probably at least generically familiar with. Everyone sees the trucks on occasions. Perhaps a number of people appreciate the uniform rental side of their business. But I think it's probably lost on people that this is a hundred -year -old plus family -owned and backed business with a rich history. Perhaps you can kind of give us the backstory of the business itself, size and scale, and Hit us with the highlights and then we'll go deeper on each of those points. Let me start with what Sintas does, who its customers are, and then I might jump into the financial overview of the business and its history.

2:59Sintas provides essential route -based services to other businesses. What I mean by route -based is that Sintas has 21 ,000 delivery vans and they have drivers going around to different customer sites and providing the service. These are essential business services. They're not core to the company's operations. So for example, a hotel business, it's there to provide good hospitality services to its clients. But there's a lot of work behind the scenes, operational services, that are involved in the day -to -day running of a hotel, which can be outsourced to third -party providers like Syntas. So it's best known for its uniform rental services, which represent about 40 % of revenue today.

3:44And what that means is businesses whose employees wear uniforms, that can include hotels, as I mentioned, can include hospitals where doctors and nurses wear scrubs, can include mechanics where they wear overalls. The business has the choice of either purchasing the uniform directly and getting the employee to launder it themselves. That involves an upfront capital commitment of maybe $500, $600 per employee. There's ongoing costs. The business has to be responsible for repairing and replacing any uniforms. The employee has to make sure they're getting the uniforms cleaned up properly. Or they can rent it from Syntas for about $1 .50, $2 per day per employee.

4:29And Syntas takes care of the whole proposition for them. They don't have to carry any inventory. There's no upfront investment, just a low ongoing charge. And the benefits of the customer is firstly, they can just focus on running their business. We're in the hotel business, not the uniform business or the laundry business. Secondly, it ensures that their employees are presentable to a high standard. Syntas will make sure the uniforms are always crisp and clean. And thirdly, for employees where the uniforms have a technical purpose, scrubs in a hospital have to be sanitized to a high standard.

5:06Overalls worn by a mechanic have to be thick cotton so they don't get burned on the job. And one that might surprise you is one of Syntas' customers is Intel. So in Intel's semi -fabs in their factories, they have to be held to unrealistically high standards of cleanliness. Even a speck of dust can compromise the quality of a semi -wafer. So Syntas provides these lint -free, debris -free astronaut suits that Intel's employees wear in the semifabs. And finally, it can deliver this service at a much lower cost than what the customer could do themselves. For customers that do uniforms directly, it costs them about two to three times as much as what Syntas charges because Syntas benefits from scale.

5:53It can negotiate with fabric suppliers and chemical suppliers to procure these suppliers at a lower cost than any individual customer. And secondly, it's a uniform specialist, whereas this isn't the core competency for its customers. And how big is Syntas' share of the uniform rental market? You mentioned the business is about 40 % of revenue. What does the rest of the business look like? So Syntas today has about a 40 % share of that outsourced uniform rental market in North America. And currently about half of the businesses in North America that use uniforms still run the programs themselves.

6:32So there's a very long opportunity for Syntas to keep taking share and converting those customers to outsource programs. So that's the first part of the business, which it's best known for. Now, as Syntas' vans are going around, over time it thought, well, what more can we do for customers while we're there? and it's leveraged its route network and customer relationships to offer other essential services. So for example, it owns 40 % of its revenue from facility services, which is things like restocking kitchen and bathroom supplies, paper towels, soaps and dispensers, rags and towels that might be used by a mechanic or in a kitchen, monthly deep cleans of carpets and upholstery in a hotel or a casino or bathrooms.

7:21That's for sanitation compliance reasons, not the same as your daily clean that might be done by a janitor. About 10 % of its revenue comes from first aid and safety. What that means is most businesses are required to have first aid kits, cabinets, eyewash stations, hand wash stations. Think of a hospital particularly. and Sintas comes in once a fortnight or once a month, inspects the first aid cabinets, makes sure they're compliant, checks the defibrillators, makes sure everything is stocked. And this is something a customer could do themselves, but who's really responsible for it? Is it Zach from finance or someone in operations?

8:02Or what if they go and leave, then who's responsible for it? Can we really do this at a lower cost than what Sintas is charging us? The answer is no. So it takes this operational burden off the customer. And again, those services are about only half outsourced today. And finally, about 10 % of revenue is from fire protection services. And here, it's a similar service. They inspect customers' fire equipment. So their extinguishers, their fire alarms, their sprinklers to make sure they're working fine. They're up to code and compliant. And they have a small business in direct uniform sales, where Syntas sells its proprietary fabrics to customers that still operate uniforms directly.

8:42And you might wonder why they would do this. The answer is it establishes a customer relationship. And over time, maybe Sintas can convince them on the value proposition of outsourcing that service. Overall, I think many investors still associate the business with uniform rentals and they underappreciate the breadth of its services. And as you say, Zach, if you walk any street in North America or into any business in North America, you'd probably see Syntas' logo on their vans, on floor and doormats, on first aid cabinets, tags on fire extinguishers and the like. And today it serves about 1 million of the 16 million businesses in North America.

9:22Just a very brief financial overview as well. Its annual revenue is close to 10 billion US dollars. It earns a 22 % operating margin, so about 2 .2 billion in operating profit and with a bit of margin expansion and buybacks and so on. It's grown its EPS pretty consistently by a mid to high teens rate. So it has quite a powerful economic engine that we can talk to later. It seems like a really dull business, but its growth, its profitability and its equity shareholder returns are among the highest in the S &P 500 over the last 20 years, 10 years, five years, really any timeframe you measure. That was an awesome summary.

10:02Clearly, to go from a business approaching $10 billion in sales, something like 21 ,000 delivery vans, has humble beginnings. I think it's a really great story of the illustration of how we got from the business's founding story in the 1920s depression to the dominant business it is today. I would love you to just give an introduction to how this business came to be and the evolution of it into what it is now. Syntas has one of the most interesting founding stories of an S &P 500 company that I've seen. As you say, Zach, it has very humble beginnings. It's a literal rags to riches story. It was actually founded by two traveling circus performers, a husband and wife duo.

10:47And in the Great Depression in 1929, they were let go in a weak economy. They were quite enterprising. They were working out how they can make ends meet. and they worked out that all these factories in Ohio where they were based use rags in their day -to -day operations. They're literal rags like old shirts and stuff that have been repurposed. They use them to wipe down equipment and so on. But once they're really dirty and oily, they can't use them anymore. So they just throw them away. So they went around to all these dumpsters and industrial garbage sites, picked up the dirty rags, took them home, washed them by hand and sold them back to the factories as new rags.

11:28And that was the business. It was called Acme Laundry back then. The next evolution of the business, which is worth mentioning, is when the founder's son, Doc's son, Herschel, became CEO. This was in the 1940s. And under his leadership, Sintas became not just another supplier to these customers, selling back the rags, it became a service company. So he realized that customers' need for these rags is ongoing. So maybe we can lease it to them rather than sell them back. And it removes the need for them to invest in the inventory. We can take that burden off their hands. It creates an ongoing relationship with Syntas and ongoing revenue for Syntas.

12:09Then it was passed on to the next generation. So Herschel's son, Richard, He became CEO at the age of 25 in the 1960s. He was Syntas' longest running CEO for nearly 30 years, quite instrumental in developing its corporate culture, which is one element of its secret sauce, its success. What he did was he expanded the business into uniform rentals. So the thought was, well, we've got these laundry facilities now. What else can we run through them apart from rags? So he came up with things like doormats, towels and wipes that you might use in a kitchen. and uniforms. And most businesses need a uniform.

12:46Any business that's customer facing, any business that has technical needs, as I said, a mechanic or a hospital needs a uniform. So it's quite a broadly applicable service. The company went public in 1983. By then, it was known as Syntas. And since then, the real big development for the business has been broadening the range of services it provides, the range of end markets that it serves, the range of customers that it serves, and in geographies as well. It entered Canada in 1995, that first aid and safety business in 1997, some of which was through acquisition, and the fire inspection business in 2003.

13:26The acquisition that's worth mentioning is in 2017, it acquired the number four uniform rental company called GNK for about $2 billion. Not huge, but it was sizable. It added 20 % to its revenue and cemented it as the clear leader in the industry. And I can't understate the family's influence on the business. They were instrumental to creating Syntas and to the leader that it is today. The founder's great -grandson is still chairman of the company, executive chairman, actually. The family still owns 14 % of the company's stock. Rare to see a situation with which a business that has this type of longevity has retained its shareholder base of family interest to a significant a proportion as it has, I think, 15 % plus.

14:14You did a great job giving the overview of the financial profile of the business, but I'd love to dig a bit deeper into what is the true economic model here? Why is it such a consistent and durable franchise? Presumably switching costs are high. I don't know that there are significant barriers to entry, but perhaps scale being one of them. I'd love to just kind of unpack the economic model that has made them such a strong business? Well, I might start with how it engages with its customers. So generally, it signs three to five -year contracts for its services, the reason being that it does need to make upfront investments in the uniforms and the supplies to serve a customer.

14:54So it needs to realize a return on that investment over a decent period. It incorporates price escalators into those contracts, but they're not a material driver of growth. They tend to be about 0 % to 2 % a year. and it bills customers simply as the service is delivered. So the uniform rentals is a weekly service. On Monday, the van will come around, it'll pick up the dirty laundry and drop off a fresh set of uniforms. The first aid restocking, I think, tends to be monthly. The facility services can be weekly, fortnightly, monthly, depending on the service. And the fire inspection audits tend to be less regular, maybe once or twice a year.

15:31As you said, Zach, Sintas does keep its customers for a very long time. Its customer retention rate is 96%, which means that on average, it keeps them for 25 years. The switching costs are reasonably high, especially if you have a contract across the customer's entire operations and you're providing a standard service for a national customer like Marriott to have to displace a service provider across all your hotels is a big ask. I think Syntas' retention is up there with the best businesses, really, like the best of breed software businesses. Its retention is also much higher than its peers. So for instance, its largest competitor is a company called Vestis, used to be called Aramark Uniform Rentals, and it has about 85%, 90 % retention rate.

16:19So that means it has to replenish 10%, 15 % of its customers every year just to stand still. And then what are the major growth drivers here? It grows organically at about 6 .5 % quite consistently, which surprises some that might consider it a cyclical business that's tied to employment growth, but its growth has been quite consistent. About 60 % of its growth actually comes from companies that are outsourcing for the first time. So it doesn't have to compete head -to -head with Vestas and Unifers for those customers. They're entirely greenfield opportunities. And that's very valuable. It means Syntas can get good pricing, means it can really pitch them on the value proposition of uniform rentals, for instance, rather than competing competitively on price or other elements.

17:05It's just a bit tougher. And it's a very durable source of growth because, as I mentioned, half of the market is still insourced. And that's even after Syntas being in business for 100 years. The rest of its growth actually mostly comes from doing more for its existing customers, cross -selling its full range of services. If you go to their website, they have probably 100 or so discrete services across those three, four areas that I mentioned earlier. That's a really valuable source of growth. It establishes these longstanding trusted relationships with its customers, 25 years on average. And with that trust, the customer can give them more of a time.

17:43Its drivers are actually salespeople in disguise. They're the ones in front of the customer every week or every month. They get to know them by name. They're the ones walking the facilities, taking a look for what else Sintas can do for them. So while we're restocking your kitchen supplies, Zach, I noticed that you have a coffee machine, but there's no mat on the floor. So if there's a spill and someone could slip on the floor, that's a liability for the business. So for $2 or $3 a week, we can give you a mat as well as the kitchen supplies. It does also win competitively. I don't want to give you the impression that it doesn't, but I think winning business from its competitors is not as important as growing with its customers and growing its customer base.

18:23And what has the business's growth meant for its financial performance, particularly as it relates to its competition? So really interestingly, when the business IPO'd in 1983, it was about the same size as the number two and number three players, Unifirst and Arama. And today it's three times the size of Vestas, the number two player, and four times the size of Unifers, the number three player. And it's just kept widening that competitive gap over time. So very impressive. It's also much more profitable than its peers. So let me give you some numbers around that. Its return on operating assets, which is its operating profit divided by working capital plus PP &E is over 50%.

19:12So that means it earns 50 cents of annual profit for every dollar of capital it invests in its operations. That's a very good return. But it's five times the return that its largest peers earn, let alone the small mom and pops that it also competes with day to day. And that's because it earns a much higher operating profit margin than its peers, about three times the margin. And it turns over its assets faster because it has a denser route network. But by itself, having a high return on assets isn't interesting if you're not growing. So Sintas' ability to keep growing at a consistently good rate and then reinvesting capital at a high rate of return to growth further is a really valuable engine of wealth creation.

19:56The growth and the high returns go hand in hand to drive that 15 % EPS growth. Importantly, probably reflecting its humble beginnings and its frugal culture, ownership operator mindset. It's always operated with a strong balance sheet around one times net debt EBITDA. And that's important. That allows it to keep investing through downturns. It offers certainty to its customers that know that Syntas will be there for them. And that's really an important differentiator versus its peers. So the number two company, Vestas, it's levered about six times, as was its parent Aramark going back. It's been a real handbrake on that business in terms of its ability to withstand the pandemic and other external shocks.

20:38Today, actually, there's more debt than equity in the capital structure of that business. And that's the number two player. So it's been a real advantage for Syntas. It's a long -term disciplined capital structure. I noticed that this business is unique in that its most significant peers are also publicly listed companies. And so you have a great case study in demonstrating the strengths of the business's economic profile and size and scale and returns and profitability. I'd be curious how it compares and to the extent that their competitive advantages continue to deepen. Yeah, it's a good observation, Zach.

21:12Although one learning from my investment career is it's very easy to focus on the publicly listed peers of a business. But those top three players combined, I think they make up about 60 % of the uniform rental market. So 40 % of the market is still in the hands of local operators, mostly mom and pops, maybe like Sintas was in the beginning. And not to undermine those competitors, I'm sure they do a very good job for their local clientele. But with those businesses comes the risk of intergenerational transfer. So does the son or daughter of the founder want to inherit the business and continue it?

21:47There's an attrition rate in those mom and pop shops. They're not able to serve customers with national, sophisticated needs. If you're just a local player, you can't serve Marriott nationally the way that Syntas can. So that's a real advantage versus small players. As is procurement, you buy vastly more materials and chemicals than a small player. So it can be more profitable and you have more resources to invest in your business and your plants and your marketing and so on. But you ask a really good question, which is, It has two sizable public competitors. So how is it that they went from being the same size 40 years ago to Syntas making eight times as much profit as the number two player today?

22:27It's a really, really wide gap. So I think part of that is also scale. Syntas, because it had a good balance sheet and a long -term mindset, it was early to consolidate the industry in its first 30, 40 years in uniform rentals. And it was able to build local and national density faster than its peers. And that was important. Scale is a massive advantage for Sintas. On the customer -facing side, for any route -based business like Sintas, where the van's going around delivering the service, local density is crucial. So basically, how many customer stops are you making each day that the driver goes around?

23:06And also, how many services are you delivering every time you stop at a customer? The higher the answer is to those questions, the more profitable you can be. The vans and the drivers are a fixed cost. So for example, in the most recent quarter, even though Syntas' revenue grew 9 % organically, a really strong result, the number of routes that it serves only grew by 1%. So its revenue per route grew substantially. And not only are there cost benefits to this, but it also allows Syntas to spend more time with its customers and build more loyal relationships. And you can see that in its EBIT margin, the cost benefit.

23:45So its operating profit margin has expanded from 14 % 10 years ago to 23 % today. And that's three times what its publicly listed peers own. So it can really serve those really large, complex needs better than its peers. It has more laundry facilities, more distribution facilities, so it can deliver a better service. And then at the back end, I think it's really underappreciated how complex a laundering or a rental operation is. So Sintas actually has over 400 branches across North America, which is where it stores its product, where it launders the product, where it repairs the uniforms. So quite a dense network.

24:28and as it grows, it can improve the utilization and efficiency of those plants. Being larger means it can spread its technology training investments over a larger base of revenue and it has purchasing scale in its supplies. And finally, the other scale advantage is Syntas has a much larger sales force than its peers, again, three times the size. And it's large enough for Syntas to have specialist salespeople in each industry that it serves. Hospitals have very different needs to semi -fabs or to mechanics. So it can really serve those customers in a way that makes sense to them. So it's a great growth flywheel.

25:08If it can grow at a higher rate than its peers, at a better margin than its peers, and reinvest that cash flow to drive further growth, it can continue its success. Yeah, that's a tough combination to compete with. would you point to any other advantages beyond scale or like what is the dominant one the second thing which differentiates syntax from its peers on the face of it laundering uniforms and restocking supplies it sounds very simple but as i said operationally it's very challenging so using uniform as an example the way it works is the uniforms get assigned to a particular employee usually.

25:46So Zach gets 11 uniforms assigned to him. There's the one that he's wearing right now. There's the five that are being laundered at the moment that are dirty. And there's the five that are waiting in the closet for him to wear for the rest of the week. Most of the uniforms even have the employee's branding on them or the employee's name on them. They're tailored to the needs of the customer, whether it's fabric, materials, sanitation requirements, so on. So Sintas has to make sure that after a week, it picks up all these thousands of uniforms together and they go through its massive laundry facilities.

26:18And it has to make sure that they're cleaned with the correct process, that they're inspected properly, and that somehow they get the clean uniform back to the right employee at the right time. It's actually a massive logistical undertaking. And the way Sintas achieves this is it tags every garment with a unique barcode. so it can track those through its facilities and they're highly automated to minimize the error in that getting back to where it needs to get to. Whereas we've heard that even its larger peers have quite manual operations. You have people literally sorting these uniforms and reading the tag and trying to work out where it's got to get to.

26:57Naturally, that comes with higher error. So Sintas has actually developed all of its garment tracking and all of its routing technology that tells drivers what optimal route they need to do for the day. It's developed that all internally. And then finally, last but not least, I think this is a really important point. I think Syntas isn't special so much for what it does as how it does it. Customers can choose from, I'm sure, dozens of uniform rental companies and dozens of facility service providers in any postcode in the US. But why do they choose Syntas? I think it mostly comes down to people and culture.