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We are recommending a new bullish trade on Cintas Corporation (NASDAQ:CTAS) — a company you probably know best for providing work uniforms and laundry services for workers in the retail and dining industry groups.
‘Ironically, this “boring” company has been oversold like a tech stock during the market’s correction, and we think this is an opportunity like the one we have been rolling over and over on Starbucks (NASDAQ:SBUX) over the last few months.
CTAS started selling off a little earlier than the rest of the market following earnings on Sept. 25. Like just about everything else this season, CTAS reported better top and bottom line numbers than the average analyst had expected.
Shares still lost 4% following the report, which is hard to explain fully, but it was probably a combination of a souring market and a slightly less positive outlook than had been expected. Before the stock could bounce back, the broader selloff had commenced.
There are a few reasons we like this position for our income focused portfolio:
1. CTAS is tied closely to hiring in the services sector which is on a continued upswing right now. All those new employees need laundry and uniforms. Since the underlying fundamentals have remained consistent, we estimate the current price makes CTAS 20% undervalued.
2. From a technical perspective, CTAS is at long-term support. The most significant pivot point over the last year is at $170, which is where the stock is currently bouncing. The stock had the bad luck to report earnings just as the market was starting to roll over, which led to its current oversold condition. The last three times the stock was in this position the subsequent rally was 50% or more.
3. From a fundamental perspective, CTAS looks great. Top and bottom line trends are very positive, and more importantly, operating margins are rising fast. So far this quarter, investors have favored improving internal margins to justify higher prices over greater topline growth. We expect CTAS’s fundamental performance to continue supporting an aggressive buyback program in the near term — especially as the stock has corrected so much since the last earnings report.
4. Finally, the premium on the options is unusually large compared to similar circumstances in the past. This situation is probably a reaction to general market conditions, but it means the premium pays an effective 11% return for a holding period half the length of our usual horizon. That makes the risk/reward of this trade very compelling and it’s rare to find that kind of return in what is usually a fairly slow-moving industry group.
‘Sell to open’ the CTAS November 16th $175 Put Write (CTAS181116P00175000) for a minimum price of $4.00.
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