UNF - UniFirst: Not First On My List

Summary

• UniFirst has been struggling for some time now, after a great operating performance in the decades before.
• The company has used a strong net cash balance to announce an apparent expensive bolt-on deal at the start of 2023.
• I fear that valuations are a bit too rich for me here, given the softer performance.

It has been all the way back to 2016 when I last looked at shares of UniFirst ( UNF ) . I thought that the provider of workforce uniforms and protective work gear was a well-led business, operating with a strong balance sheet, as investors awarded the company rich multiples at the time.

A Recap

UniFirst is a producer of uniforms and protective gear, as well as ancillary services like cleaning and personalization. Closely run by the Croatti family, the company has seen steady growth, with revenues reported at nearly $1.5 billion in 2015, mostly from the US and Canadian rental and cleaning operations. Despite a competitive field, the company posted solid operating earnings of around $200 million, translating into decent double-digit operating margins.

As its peer Cintas ( CTAS ) , which at the time was far larger with $5 billion in sales, announced its next M&A move, UniFirst made a smaller move as well. At the time, UniFirst announced a $122 million deal to acquire Arrow Uniform, adding just over $60 million in annual sales, at a sales multiple which marked a small premium to its own valuation. The deal would reduce net cash holdings to $225 million, still significant with 20 million shares outstanding.

With shares trading around $132, the $11 pro forma per share net cash position worked down to a 21 times earnings multiple. Finding that valuation a bit too rich, I am glad that I did not get involved seven years ago.

What Happened?

Shares of UniFirst rose to $200 per share ahead of the pandemic, fell during the pandemic for obvious reasons as the business was impacted in a major way, yet shares rallied to $250 in 2021. Ever since, shares have traded in a $150-$200 range, now trading towards the higher end of the range, essentially the same level seen in 2018 already. The 50% return over a 7-year time window is relatively modest, given that the current yield of UniFirst stock comes in at a very modest 0.6%.

Through 2021 the company has grown to a $1.8 billion revenue base, marking the most growth from 2016. The company is huge in terms of scale, serving 300,000 customers through its employee base of 14,000 workers which provide outfits to 2 million employees a day. With a 5% market share in its estimated market opportunity measuring $39 billion, the company trails Aramark ( ARMK ) with a 7% market share and Cintas which holds about 14% of the market.

Lack of growth in 2020 and 2021 amidst lockdowns in many sectors made that revenues were stuck around $1.8 billion those years, pressuring operating margins from the low double digits towards the 10% mark.

In October of last year, UniFirst posted its 2022 results, as inflation and a recovery coming out of Covid-19 drove a near 10% increase in sales to $2.0 billion. That was about the good news, as operating earnings fell from $196 million to $134 million. Reported net earnings fell 31% to $103 million, with earnings per share down from $7.94 per share to $5.46 per share. Adjusted earnings fell as well, albeit much less pronounced, with adjusted earnings seen at $6.81 per share. The with adjustments related to investments into CRM and ERP systems, as inflationary pressures hurt the business as well.

Modest buybacks made that the share count has fallen to just over 19 million shares, as net cash holdings of $376 million have risen to $20 per share. With a $3.8 billion equity valuation at $200, the operating asset valuation comes down to about $3.4 billion, equal to about 1.7 times sales and 26 times adjusted earnings. Amidst inflationary pressures, the company guided for 2023 sales around $2.15 billion with GAAP earnings seen at a midpoint of $5.70 per share, including about a $2 per share pre-tax Key Initiative costs, for adjusted earnings of just over $7 per share.

A Bolt-On Deal

Taking advantage of its strong net cash position, UniFirst announced a $300 million deal to acquire Clean Uniform, as announced in February of this year. Adjusted for the incremental tax benefits, the effective purchase price falls to $260 million. With a $90 million revenue contribution, the deal price is quite steep around 3 times sales, evaporating the net cash balances to an important extent, while adding about 4-5% to pro forma sales. Few financial details have been announced other than the sales contribution, with more details set to be released alongside the first quarter earnings report.

With adjusted earnings seen around $7.30 per share, I assume just modest earnings per share accretion. Working with an adjusted earnings number of $7.50 per share, most of the net cash position will be evaporated. This means that earnings multiples still come in at a 25-30 times range, albeit hurt by lower than historical operating margins, as I fear that the valuation is simply too high for me.

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