Rentokil Initial: A serial acquirer in the making
Rentokil Initial: A serial acquirer in the making
This report is coming later than expected due to Rentokil's stock price diving over 20% following its trading update on 11th September, where expectations for North America were revised downward (see Rentokil Initial Update).
Source: Koyfin (affiliate link with a 20% discount for StockOpine readers)
To get up to speed with its fundamentals, you can read our February article titled Rentokil Initial: Potential Opportunity in Pest Control. If you're short on time, this quote from CEO Andy Ransom highlights the company's future growth drivers:
“In Pest Control, we operate a simple, repeatable model in a global market that is underpinned by structural growth drivers, including urbanization, growing middle classes, population growth, climate change and increased regulatory pressure, particularly in food safety.”
Brief Overview: Rentokil Initial operates in 90 countries, with around 80% of its revenue from pest control services, while 61% is generated in North America. 74% of its pest control revenue comes from North America. The company offers a range of solutions, including rodent and insect management, wildlife control, and hygiene services such as washroom and clinical waste management. These services are recurring, with a customer retention rate of 82.3%, slightly below its historic average due to the Terminix acquisition in October 2022 but showing improvement.
Source: Company filings, StockOpine analysis
Investment thesis: In October 2023, Rentokil's share price experienced a sharp decline following signs of softened demand in the US, its largest market. A second drop followed in September 2024, again driven by underperformance in North America. However, we believe this decline is excessive, as the market seems to be overlooking Rentokil's international expansion, underpenetrated opportunities, and synergies from the Terminix acquisition. While branch consolidation efforts are progressing, with minor disruptions due to the complexity of the acquisition, improvements in route density are evident. However, inefficiencies over July and August, caused by overtime work to secure extra business, led to cost overruns.
Does this break the thesis? Let’s dive in and update our valuation.
Contents:
Performance Update
Industry
Valuation
Conclusion
1. Performance Update
We will break this section into 5 parts, namely North America, Profitability, International expansion, Acquisitions and Pest Control. But first, a snapshot on overall performance.
As of H1 2024, Rentokil’s TTM revenue reached £5.4 billion, growing at a 15.3% CAGR since 2018, with reported operating income at £642 million, reflecting a 19.1% CAGR.
Source: FinChat.io (affiliate link with a 15% discount for StockOpine readers)
a. North America
Source: Company filings, StockOpine analysis
As evident from the chart above, organic growth rates in North America have trended downward, with 2.2% in Q3 2023 and 1.2% in Q4 2023. However, growth improved to 1.5% in Q1 2024 before slipping slightly in Q2, due to a drag in product distribution (despite a 50 bps improvement in Pest Control), resulting in a half-year organic growth rate of 1.3%. This stabilization at such low levels, especially when Rollins, its closest competitor, achieved +7% organic growth over the last four quarters, explains why the market is penalizing the company. Management has acknowledged its struggles in attracting and closing deals, and is now focused on addressing these weaknesses.