Our financial risk assessment incorporates our forecast for credit ratios to continue improving to levels firmly within a "modest" financial risk profile, for liquidity to remain "strong," and for the company's financial policies to remain conservative. Our forecast for key credit ratios is as follows:
-- The ratio of adjusted total debt to EBITDA modestly improves to between 1.8x and 1.9x through fiscal year-end 2014 (May 2014).
-- Funds from operations (FFO) to total debt modestly improves to between 43% and 45% through fiscal year-end 2014.
-- Total debt to capital modestly improves to just below 40% through fiscal year-end 2014.
Financial ratios indicative of a modest financial risk profile include adjusted total debt to EBITDA between 1.5x and 2.0x, FFO to total debt between 45% and 60%, and adjusted total debt to capital between 25% and 35%.
Standard & Poor's economists believe the risk of another U.S. recession during the next 12 months is between 20% and 25%. We expect GDP growth of just 2.1% this year and only 1.8% in 2013, consumer spending growth of between 1.9% and 2.2% per year through 2013, crude oil per barrel (WTI) finishing 2012 near $94 and finishing 2013 near $90, and the unemployment rate remaining around 8% through late 2013. (see "U.S. Economic Forecast: Long Time No See," published Oct. 15, 2012, on RatingsDirect). With these economic forecast considerations in mind, our base-case forecast for the company's operating performance over the next two years is as follows:
-- Consolidated revenue growth between 4.0% and 4.5% through fiscal year-end 2014 (May 2014). We forecast the first aid, safety, and fire protection segment will increase between 7% and 8% through fiscal 2014. We forecast the document management services (DMS) segment will only increase 2% in fiscal 2013 because recycled paper prices are much lower compared with the prior year. DMS growth then recovers to between 5% and 8% as recycled paper prices stabilize and the company gains new accounts. We forecast rental uniforms and ancillary products will grow between 3% and 4%, with ancillary products growing faster than uniform rentals.
-- Gross margin (excluding depreciation and amortization) between 46.0% and 46.5% through fiscal year-end 2014. Benefits from employee productivity, scale, and route density should continue to offset elevated material and transportation input costs.
-- Selling, general, and administrative (SG&A) expenses grow at between 50% and 75% the rate of revenue growth. The benefit from SG&A expense leverage begins to lessen as many expenses are eliminated.
-- EBITDA margin modestly improves to between 18.0% and 18.5% through fiscal year-end 2014, primarily from top-line growth and SG&A expense leverage.
-- Free cash flow between $325 million and $400 million per year, with working capital fluctuations mostly responsible for the $75 million range.
-- Capital expenditures increase to between $200 million and $225 million per year as the company increases investment to support growth. We believe capital expenditures will remain near 5% of revenue for the foreseeable future.
-- Shareholder returns continue to be funded with internally-generated cash flows. We forecast share repurchases of between $190 million and $250 million per year and dividends of about $70 million per year. We believe the company would reduce share repurchases if attractive acquisitions were available. We do not anticipate a transformative acquisition over the next year.
-- Reported debt outstanding remains near $1.3 billion. We believe the company will continue to refinance upcoming debt maturities even if they have the available cash to repay the maturities, assuming the interest rate environment remains attractive. This was the case in June 2012 when the company refinanced its $225 million 6.0% notes due 2012 with $250 million 3.25% notes due 2022.
Cintas has a well-established position in North America as a provider of rental uniforms and ancillary products, such as entrance mats and restroom supplies (facility services). These areas represent more than 70% of Cintas' more than $4 billion of revenue. The company's expansion into facility services is reducing its dependence on employment levels. A sustained rise in certain uniform material and transportation input costs could modestly hurt profitability, especially if employment levels fail to materially improve. We believe a rise in transportation costs has a greater immediate impact because uniform material costs are amortized over a uniform's useful life. The company has offset elevated input costs by increasing volumes through successful cross-selling of ancillary products and through gaining new non-uniform rental customers. We forecast ancillary products growth will continue to outpace uniform rentals growth.
Cintas has a diverse customer base, with over 1,000,000 customers. We believe no customer accounts for more than 1% of total revenue. This large and diverse customer base is an asset as they company seeks cross-selling opportunities in its newer business segments, such as first aid, safety, and fire protection services and document management services. These newer segments each account for about 10% of total revenue, and we expect each to grow faster than the uniforms rental business. We believe Cintas will remain a small participant in these segments for the foreseeable future.
Cintas' short-term and commercial paper rating is 'A-2'. We view the company's liquidity as "strong," as our liquidity criteria define the term. We expect the company's cash sources will exceed its cash uses over the next 24 months. Our assessment of the company's liquidity profile includes the following expectations, assumptions, and factors:
-- We forecast cash sources to exceed cash uses by more than 1.5x over the next 12 months, and to remain positive over the next 24 months.
-- We forecast positive net sources over the next 12 months, even if EBITDA declines by more than 30%.
-- We expect financial maintenance covenant cushion to remain sufficient.
-- The company's debt maturity profile is attractive. The company's notes maturities range from 2016 to 2036. In October 2011 the company extended its $300 million revolving credit facility maturity to October 2016 from September 2014.
-- We believe the company has good banking relationships and a satisfactory standing in the capital markets.
As of Aug. 31, 2012, we calculate the company had total liquidity of about $580 million, which included revolver availability of $300 million and surplus cash of about $280 million. (Our calculation excludes cash located in foreign jurisdictions.) The company's average total liquidity over the past eight quarters is about $475 million. We forecast liquidity will remain consistent with this average.
We forecast free cash flow of between $325 million and $400 million per year, with working capital fluctuations mostly responsible for the $75 million range. We believe capital expenditures will increase to between $200 million and $225 million per year as the company increases investment to support growth. We estimate capital expenditures will remain near 5% of revenue for the foreseeable future. We expect shareholder return initiatives will continue to be funded with internally generated cash flows. We forecast share repurchases of between $190 million and $250 million per year and dividends of about $70 million per year. We believe the company would reduce share repurchases if attractive acquisitions were available. We do not anticipate a transformative acquisition over the next year.
The outlook is stable, which reflects our forecast for credit ratios to continue improving to levels firmly within a "modest" financial risk profile, for liquidity to remain "strong," and for the company's financial policies to remain conservative. The outlook also reflects our expectation for the company's satisfactory business risk profile to remain appropriate amid weak employment levels and slow economic growth.
We could raise our ratings if adjusted total debt to EBITDA declines to about 1.5x. This is most likely to occur through a more conservative financial policy because we believe the company will remain dependent on improved employment levels and stronger economic growth. Based on first-quarter fiscal 2013 results, debt reduction of more than $325 million would be necessary for adjusted total debt to EBITDA to approach 1.5x.
We could lower our ratings if adjusted total debt to EBITDA increases to the high-2x area. This is most likely to occur through a more aggressive financial policy, including debt-financed share repurchase and acquisition activity. Based on first-quarter fiscal 2013 results, a debt increase of $600 million would be necessary for adjusted total debt to EBITDA to increase to the high-2x area.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology and Assumptions: Liquidity Descriptors for Global Corporate Issuers, Sept. 28, 2011
-- Corporate Ratings Criteria 2008, April 15, 2008