Description

UniFirst (“UNF” or “the Company") is the third largest garment rental business in the U.S. The principal services of its core laundry operations segment (89% of FY 2019 revenues) business include providing customers with uniforms and other non-garment items, picking up soiled items on a periodic basis (usually weekly), and delivering, at the same time, cleaned and processed items. Within the Company’s core laundry operations, the Company also provides a number of non-garment safety and cleaning products that should be in high demand by its customers in the wake of the pandemic. Some notable customers include Coca-Cola, Comcast, Costco and Walmart. 

UniFirst’s core business generates about 20% of its revenues from large/national accounts with the remainder coming from small and medium sized businesses. Accordingly, UNF is not immune from the headwinds facing many small/local businesses during the current pandemic. However, UniFirst does have a diversified customer base with some benefiting from the current environment, though not enough to offset the headwinds faced by many of its customers. The following provides a breakdown of a few of the notable industries UNF serves:

• 17% - Manufacturing
• 16% - Auto related (dealerships, manufacturing, gas stations, repair shops, etc.)
• 8% - Food stores and food manufacturing
• 6.5% - Eating/drinking places (mostly restaurants, some hospitality)
• 5% - Energy
• 4% - Health care (includes hospitals and medical retail such as urgent care facilities)

   

In addition to its core business, UniFirst has a specialty garments segment (7% of FY 2019  of revenues) that provides garment and non-garment items for customers requiring nuclear and cleanroom applications including government agencies, research and development laboratories, high technology companies, and utilities operating nuclear reactors. UniFirst also operates a first aid business (3% of FY 2019 revenues) that sells first aid cabinet services and other safety supplies, and operates wholesale distribution and pill packaging operations.

UniFirst maintains a dual class share structure with members of the Croatti family holding a 20% economic interest, but controlling 71% of the votes (note: historically, members of the Croatti family have individually voted their respective shares). Following the passing of UNF’s long-time CEO Ronald Croatti in 2017, the Company appointed its then CFO (Steven Sintros) to take the reins of the Company. There are two Croatti family members in senior executive positions at the Company, both ostensibly passed over for the CEO appointment by the board, including Cynthia Croatti (Ron’s Sister; Treasurer/Human Resources) and Michael Croatti (Ron’s son; SVP, Operations).

UniFirst has been profiled twice before on VIC (by GrizzlyBear in 2016 https://www.valueinvestorsclub.com/idea/UNIFIRST_CORP/2597866607 and falcon44 in 2017 https://www.valueinvestorsclub.com/idea/Unifirst/4809279506) and the previous posts and comment threads contain valuable information. The intent of this write-up is to highlight the Company’s attractiveness and opportunities in light of recent developments. 

Key Investment Considerations:

Fortress Like Balance Sheet:

At the end of the most recent quarter (2Q FY 2020; February 2020), UNF had $395 million of cash (11% of its current market cap) and no long term debt. UNF’s strong financial position should help it to both manage through the current downturn and capitalize on opportunities that may be presented as a result of the pandemic. During UNF’s most recent earnings call held on April 1, 2020, UNF CEO Sintros stated that acquisitions would be considered in the current environment. With approximately 20% of the market controlled by smaller mom and pops (~600 companies with annual revenues less than ~$100 million), we would not be surprised if a number of these firms are currently facing meaningful financial difficulties. Importantly, UNF is likely positioned as the acquirer of choice. Cintas (at over 40% market share) is probably at/near the upper limit from a regulatory perspective while Aramak is heavily levered following a number of acquisitions in recent years. The prospect for increased market share for UNF is important as it has the potential to expand profitability especially if market share gains come in areas where it operates less dense routes. The current downturn could also enable UniFirst to build a bigger presence in tangential markets (uniform sales, linen supply, ancillary services such as cleaning supplies, etc.) via opportunistic M&A. The addressable market in the core garment rental business is ~$8-$9 billion, but factoring other related opportunities that amount increases to ~$20 billion. Moreover, the total addressable market (uniform rental and related services) is expected to increase to ~$34 billion over time due to growth in its various components and as companies that currently insource look to outsource (e.g. ~30% of companies conduct their uniform programs in house). UNF also has the ability to repurchase shares and we would not be surprised if UNF was buying a meaningful amount of shares during the pandemic. In early April, with shares at depressed levels, management did not rule out the potential for buybacks.

Additional Financial Flexibility:

In addition to the UNF’s strong financial position, it also warrants mention that it owns about half of its facilities. This should also help UNF better manage through the current downturn relative to peers (lower required lease payments), but could also serve as an additional source of liquidity.  

Recurring/Contracted Revenue Streams:

UNF boasts an attractive business model that traditionally offers good revenue and cash flow visibility. Contracts are typically for ~5 years (a function of the upfront investment UNF makes for uniforms with a new customer) while customer retention averages about 90%. Higher retention rates are experienced for its national accounts that represents about ~20% of revenues in the core business. Moreover, customers tend to stay with UNF for multiple terms. 

Favorable Industry Competitive Landscape and Market Share Gains:

Following recent industry M&A, the core domestic (U.S.) uniform rental industry is nearly an oligopoly with the top three players controlling ~78% of the industry. The oligopoly structure is particularly true with regard to the national accounts business. In our view, this should bode extremely well for the remaining top three participants including UNF by offering the potential for a more rational industry pricing environment that should bolster profitability. Recent M&A has included Cintas’ acquisition of the #4 player (G&K Services in 2017; 14x EV/EBITDA) and Aramark’s deal for the #5 player (Ameripride in 2018; 12x EV/EBITDA post tax benefits). We would not be surprised to see UniFirst pick up market share as a result of the transactions and note that the multi-year nature of industry contracts should continue to present UNF an opportunity to capture share as disgruntled customers of the recently acquired companies ultimately seek out a new provider in the wake of these transactions.

Margin Expansion Opportunities:

UniFirst’s operating margins trail peer Cintas by ~500 basis points. As we noted previously, a more rational pricing environment as a result of recent M&A could help expand margins from current levels. Although UNF may not be able to fully close the gap due to the scale that Cintas enjoys, we detail a number of other opportunities that could help expand profitability going forward.

• Increased Market Share: Management has noted that the best opportunity to boost margins is by filling in business within its less dense routes. UniFirst’s potential to pick up market share via M&A and other means could bode extremely well for future levels of profitability. Should a number of UniFirst’s smaller competitors fall by the wayside as a result of the recent pandemic, UniFirst looks well positioned to capture additional market share.The recent opening of a new state-of-the-art-facility in the greater Los Angeles area should also help the company attract customers in that market including those of competitors that are unable to survive the current challenges.
• New Opportunities and Ancillary Services: The pandemic has created its fair share of headwinds, but there will also likely be a number of opportunities. There could be the potential for expanded relationships with customers especially around service offerings of masks and other protective clothing. In addition, cleaning supplies, which UNF also delivers to its customers, will also likely be in greater demand for the foreseeable future. 
• New CRM System: The Company’s attempt to build its own customized CRM system failed miserably and UniFirst walked away from the endeavor, but not before taking a $56 million impairment in the 4Q 2017. UniFirst is currently working toward rolling out a CRM system from an established industry vendor (ABS Laundry Solutions) and expects to begin testing the system at select locations during the second half of the Company’s current fiscal year (ends August). The new system, which Aramark is also deploying across all of its uniform rental business following that company’s acquisition of Ameripride (which was utilizing the ABS solution that UNF is looking to deploy). During Aramark’s most recent earnings call management stated that it believes that there’s “significant runway and margin improvement potential” as it deploys the application more broadly across its organization.

Shareholder Friendly Initiatives:

Following the passing of the Company’s long-time CEO in 2017, the Company has become more shareholder friendly and has taken steps to optimize the Company’s overcapitalized balance sheet.  In 2018, UNF deployed $146 million in the purchase of shares (1.2 million) from the Croatti family, including the estate of the late CEO, at $124 a share representing a 17% discount to the prevailing market price.  Following the repurchase from the Croatti family in 2018, the Company established a $100 million share repurchase authorization in 2019 and has deployed $45 million in the repurchase of 0.3 million shares (average price: $166.71 a share) to date. The Company has also boosted its dividend meaningfully in each of the past two years with the annual payout rising nearly 7 fold from ~$0.15 a share to $1.00 a share (0.6% yield) though we note that at a payout ratio of just ~11% there should be room for additional increases. It should be noted that the dividend for the common stock is 25% greater than the dividend for the Croatti family’s super-voting shares, which stands at $0.80 a share. In our view, this could be interpreted as a sign of the Company’s shareholder friendly motivations and desire to unlock shareholder value over the longer term. 

Compelling Valuation:

Although shares have rebounded by ~40% from recent lows, they are still down about 17% from recent 52-week highs. At current levels, shares are trading at ~9x ttm EBITDA. Although the Company’s trailing EBITDA is unlikely attainable in the near term, we would not be surprised to see this level ultimately achieved in the next 1-2 years as conditions begin to return to normal. It should be noted that the Company’s current valuation (based on TTM EBITDA) is well below (~30%) where recent precedent industry transactions have occurred (~13x). We would also note that UNF is trading at a meaningful discount to the ~15x multiple that peer Cintas has traded at on average over the past decade. 

Other Considerations: Acquisition Candidate or Transformational Acquisition?:

With UNF in the process of installing a CRM solution that is from the same vendor that Aramark is using and currently deploying across its uniform rental business, we believe the common platform could help facilitate a future transaction between the companies. With the passing of UNF’s CEO in 2017, we thought that UNF might consider selling at some point and Aramark seems like a logical fit. The 2018 decision by certain Croatti family members to sell shares might suggest that they are not wedded to business longer-term. However, with Aramark operating with elevated leverage (net debt/EBITDA: 5.2x) as a result of the recent acquisitions, it could provide an opportunity for UNF to pursue an opportunistic transformational deal for Aramark's uniform business, which would help that company address its leverage/liquidity issues. If UNF were to pursue an opportunistic deal of Aramark’s garment rental business (about the same size as UNF with about 18% garment industry market share) in the near term, or as conditions begin to return to normal, we believe that there would be significant operating synergies that could be realized. Cintas and Aramark initially targeted synergies of $140 million and $70 million, respectively from their recently announced transactions.

Exposure to Energy Region is Key Risk to Consider: 

In addition to the uncertainty associated with the pandemic, The Company’s exposure to the energy industry is another key risk to consider. UniFirst currently generates about 5% of its business from energy companies, though this amount is down from ~10% a few years ago. UniFirst is more exposed to energy-producing regions of the country than its key peers are. The dramatic decrease in oil prices beginning in 2014 negatively impacted the Company’s energy customers as they curtailed their operations, which impacted not only the Company’s oil-related customers but also customers servicing the oil industry and customers in unrelated businesses that benefited from the expansion in years preceding the oil price declines.  Although UniFirst benefits from the lower energy prices in terms of fuel savings for its vehicles and natural gas costs to run its plants, management estimates that significant decreases in energy prices would have an overall negative impact on its results due to cutbacks by customers in or dependent on the oil and natural gas industries, which would outweigh the benefits in the Company’s operating costs from lower energy prices. Although UNF’s energy exposure is worth monitoring, there could be some benefits. UNF's peers in the energy region could face greater than normal stress than peers in other areas of the country providing an opportunity to pick up share via M&A or simply by default from competitors that can’t make it through the pandemic. 

Catalyst

• Market share gains as a result of recent industry consolidation or via M&A as a result of the current coronavirus crisis due to the Company’s robust balance sheet
• Optimization of the Company’s over capitalized balance sheet (no debt) via increased dividends and/or share repurchases
• Increased demand for existing products (cleaning supplies) or expansion of relationships with clients (face masks, protective equipment, etc.) as a result of the current pandemic
• Deployment of the Company’s CRM system, which could help bolster margins
• UNF is likely an acquisition candidate at some point though the possibility that it could complete an opportunistic transformational acquisition that would offer meaningful synergies is not out of the question especially with its strong balance sheet