UNF - UniFirst: Workwear Play Starting To Look Interesting

2023-07-06 12:05:59 ET

Summary

• UniFirst Corporation shares have sold off quite a bit in recent months.
• A 25% pullback in the share price starts to look compelling here after the company has seen real margin struggles and a bolt-on deal.
• Valuations look a lot more reasonable, although I fail to see an immediate trigger here.

In February, I concluded that shares of UniFirst Corporation ( UNF ) did not deserve a place on my list. This came after the business has been struggling for some time now, despite a solid performance in the decades before. Following an apparently expensive bolt-on deal at the start of 2023, I felt that valuations were a bit too rich for me to get involved.

Creating Some Perspective

UniFirst is a producer of uniforms and protective gear, as well as related and ancillary services like personalization of these uniforms and cleaning. Run by the Croatti family, the company generated $1.5 billion in sales in 2015, with sales predominately derived from U.S. and Canadian rental and cleaning services, with operating profits posted around $200 million.

These were decent numbers, but the company was still much smaller compared to its larger publicly traded peer Cintas Corporation ( CTAS ) . Over the past years, the company has grown to a $1.8 billion revenue base in 2021, as the company commanded a roughly 5% market share in a near $40 billion market segment which is dominated by Cintas, and to a smaller degree by Aramark ( ARMK ) .

In October 2022, UniFirst posted its 2022 results, a year in which sales rose by 10% to $2.0 billion. This looks solid, but this was achieved in an inflationary environment, of course. This was seen as operating earnings fell from $196 million to $134 million, with net earnings down 30% to $103 million. Consequently, earnings fell from nearly $8 per share to $5.50 per share. That is part of the story as adjusted earnings fell in a smaller way to $6.80 per share, as the company excluded for some costs related to new CRM and ERP systems, on top of general margin weakness due to inflationary pressures.

With 19 million shares trading at $200, the company commanded a $3.8 billion equity valuation. This included a $376 million net cash position, which adjusted for makes that a $3.4 billion valuation comes in at 1.7 times sales and 26 times adjusted earnings, marking steep earnings multiples. While 2023 revenues were seen up to $2.15 billion, it was a GAAP earnings outlook of $5.70 per share and adjusted earnings number of around $7 per share, which were not too impressive.

That net cash position would largely become depleted as the company announced a $300 million deal to acquire Clean Uniform at the start of this year, although the price would fall to $260 million after factoring in tax benefits. The $90 million revenue contribution reveals that the acquired business is valued around 3 times sales, while the own business trades at less than 2 times sales.

With few other financial details announced, I was a bit skeptical on the deal, adding about 4-5% to sales, while evaporating the net cash balances. Trading at a 25-30 times earnings multiple, albeit based on historically lower margins, I was cautious, in the sense that I did not see appeal.

Coming Down

Fast forwarding between February and today, we have seen UniFirst Corporation shares lose about a quarter of their value, trading at $154 per share here. Shares fell by the end of March as the company released its second quarter results. Quarterly revenues of $542 million were up 11% on the year, as operating earnings were down 8% to $20.7 million.

The Clean Uniform deal closed on the 13th of March, which was actually just after the quarter ended. The fact that the company guided for EBITDA margins of 10% for that business, reveals that margins are actually trailing, or are largely in line with their own business, which means that 3 times sales multiple being paid looks very high.

The company hiked the full year sales guidance by $60-$70 million to $2.21-$2.22 billion, but this is simply the addition of the Clean Uniform contribution. GAAP earnings are now seen between $5.02 and $5.37 per share, including the Clean Uniform deal, which is not too inspiring.

By the end of June, the company posted third quarter results with revenues up nearly 13% to $577 million, with growth aided by the Clean Uniform deal. Operating earnings fell a percent to $33 million and change.

The company increased the full year sales guidance by ten million to $2.22-$2.23 billion with GAAP earnings still seen between $5.02 and $5.37 per share, although that gap to adjusted earnings was actually reduced to $1.60 per share, indicating that the performance is a bit softer than expected. Following the deal, net cash balance has been largely depleted at $69 million, equal to about $3.50 per share.

And Now?

The reality is that UniFirst Corporation has seen real operational margins struggle and has made an expensive deal, which by no means is fatal as the company still has a net cash position here. The issue is that even if we kindly adjust for the items, earnings fall short to $7 per share, which means that just north of $150, the unleveraged business still trades at 20-21 times earnings. That is a much lower multiple than the 25-30 multiple at which shares traded earlier this year, but still demanding.

The reality is that one has to strike a balancing act for the shares here. Based on current earnings multiples, valuations have come down, but this is based on the fact that margins come in below historical averages. If the company can return to 10% margins, EBIT of $220 million might easily translate into earnings of $9 per share, let alone the observation that margins came in the mid-double digits in some years before.

Given this, I am becoming a lot more upbeat here about UniFirst Corporation from a valuation perspective, although I fail to see the trigger for a quick turnaround. With shares down to their lowest levels in the past 6-7 years, while sales have continued to advance, appeal seems to lie here for those investors with a long-term horizon in anticipation of recovery to historical margins.

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