April 6, 2015
This Unlikely Victim of Oil's
Collapse is Headed for a Sell-off
By Joseph Hogue
The decimation of oil prices has been a dominant theme for the past eight months. However, while weaker earnings out of the energy complex are weighing on overall market earnings, the collapse in oil prices has yet to really hit earnings outside the sector.
But that could be about to change. While companies like airlines and shipping providers may benefit from lower fuel prices, companies that provide ancillary services to the energy sector may soon surprise the market with lower sales.
One particularly expensive-looking company already warned investors, but no one seemed to notice.
Cintas (NASDAQ: CTAS) is the largest U.S.-based uniform rental provider with more than 7,700 delivery routes and 1 million business clients. Beyond a commanding domestic presence, the company has operations in Asia, Latin America and Europe.
Revenue from the core rental business accounts for 75% of sales and 80% of profitability. While Cintas has been able to carve out a name for itself in the mature market of rental uniforms, it has struggled in its other segments -- direct uniform sales and first aid, safety and fire protection services.
The attempt to diversify sales into these segments through acquisitions over the past decade has reduced returns and exposes the company to increased competition and execution risks in other industries. Return on invested capital has fallen from 12.7% in 2006 to 11.9% last year as the company spends more to develop the new segments.
Furthermore, its business model is heavily exposed to the employment cycle, which has helped drive sales over the past few years. As employment growth levels off, the company may find itself struggling to maintain revenue growth.
Shares are already relatively expensive, trading at 22.6 times trailing earnings compared with an average multiple of 19.3 over the past five years.
It seems insiders are getting a bit nervous about the share price as well, with the company's director and former chairman, Richard Farmer, selling $8.2 million worth of stock in December at $79.81 per share. Chief Operating Officer Phillip Holloman also sold a block of shares for close to $550,000 late last year at $78.30 per share.
While investors have been focusing on the benefit of lower gasoline prices for the uniform rental company, there could be another catalyst that will drive shares lower when Cintas reports earnings in June.
While the company managed to beat earnings expectations by $0.06, posting EPS of $0.85 a share, when it reported its fiscal third-quarter results on March 18, management sounded an ominous tone when it came to sales over the next few quarters.
The company does not break down the percentage of sales to businesses in the oil and gas industry, but CFO Mike Hansen warned, "While we did not see any noticeable revenue impact in the third quarter from our oil and gas related customer, we did began to hear from them that a negative impact is coming."
Shares are down 4% since that report but still up more than 20% over the past six months. Earnings are expected to rise 12% to $0.85 per share in the coming quarter against expectations for a 0.8% year-over-year decrease in sales to $1.15 billion. Management needs to make some serious progress on margins if it is going to meet earnings expectations with no sales growth.
I think the company is likely to disappoint in June, and see shares falling back to around $76, which is about 8% below the current price. That's a decent return for a short seller, but using a put option strategy, traders can amplify that return into 71% profits.
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With shares of CTAS trading around $82.69 at the time of this writing, I am interested in buying CTAS Aug 82.50 Puts for a limit price of $3.80 per share ($380 per contract). The August option gives us time to benefit from a post-earnings sell-off in June or close out the position if earnings do not disappoint.
The trade breaks even at $78.70 ($82.50 strike price minus $3.80 options premium), which is 4.8% below current prices. If CTAS hits my $76 downside target, the put options will be worth at least $6.50 ($82.50 strike minus $76 share price) for a gain of 71%. Place a good 'til cancelled (GTC) order to sell your puts at that price.
Recommended Trade Setup:
-- Buy CTAS Aug 82.50 Puts for $3.80 or less
-- Set stop-loss at $1.90
-- Set price target at $6.50 for a potential 71% gain in three months
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