Rentokil Initial: Potential Opportunity in Pest Control

In today's report, we're delving into Rentokil Initial, a company that has caught our attention because of its leadership position in the pest control industry, an industry which provides a long-term opportunity for consolidation. The attractiveness of the pest control industry lies in its recurring revenues and the enhanced profitability that comes with scaling operations and building density within customer networks. Recent indications of softened demand in the US, as highlighted by Rentokil’s management in October, have caused a sharp decline in the stock price from the £6.00 range in October to £4.3 today. Today, the company trades at EV/Sales and EV/EBITDA multiples approximately half of those of its closest US competitor, Rollins, Inc.

Through our analysis, we provide a comprehensive overview of the company and its competitive landscape while we conclude our assessment with a discounted cash flow (DCF) calculation.

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1. Key Facts

Description: Rentokil Initial plc (“Rentokil”, “Company”), with ticker symbol $RTO, is the largest pest control company in the world. The Company operates in 90 countries with approximately 77% of its revenue generated from pest control services.

Key Financials: Over the period FY13 to trailing twelve months (“TTM”) Q2 FY23, the Company depicted a revenue Compound Annual Growth Rate (“CAGR”) and operating income CAGR of 11.0%, reaching a TTM revenue of c. £4.81 billion and operating income of £633 million (margin of 13.2%). Rentokil has cash and short term investments of £1.4 billion compared to total debt and lease liabilities of £4.7 billion.

Price & Market Cap (as of 23^rd February 2024): Its market cap is £10.7 billion with a 52-week low of £3.88 and a 52-week high of £6.64, whereas it currently trades at £4.29.

Valuation: Rentokil trades at a TTM EV/EBITDA of 13.0x (4 Year average of 17.4x) and a TTM EV/Sales of 2.9x (4 Year average of 3.9x).

2. Business Overview

“Commercial customers rely on pest control to protect their customers and these services are also often required by law. Residential customers have a low tolerance to pests in their homes and want problems resolved quickly and professionally. As a result, there is a relatively low sensitivity to prevailing economic conditions.” Andy Ransom, CEO

a. History

Rentokil's roots trace back over a century when Harold Maxwell-Lefroy, the Professor of Entomology at Imperial College, was tasked with investigating methods to eradicate death watch beetles infesting Westminster Hall in the UK. Maxwell-Lefroy pioneered the development of the first fluid, named Ento-Kill, specifically formulated to combat woodboring beetles. Initially intending to register the name "Entokill," he pivoted to "Rentokil" due to existing trademark constraints, thus establishing Rentokil Ltd as the name of his company.

Source: Rentokil Website

The UK-based company debuted on the London Stock Exchange in 1969 and throughout the 1980s and 1990s, the Company performed phenomenally well, once voted as Britain’s most admired company due to consistently delivering growth in the 20% range under the leadership of Sir Clive Thompson. After the hostile takeover of BET plc in 1996, Rentokil acquired the Initial business, specializing in washroom and hygiene services, which now contributes approximately 18% of the Company’s revenues.

Over the years, Rentokil grew organically and through acquisitions expanding its operations all around the world. In 2022, the Company solidified its position as the world's largest pest control company by acquiring Terminix for $6.7 billion, thus extending its services to approximately 4.9 million customers worldwide.

b. Strategy

Rentokil operates under a predominantly subscription-based model, serving a diverse clientele ranging from multinational pharmaceutical, industrial and food production companies to local shops, restaurants and homes. With over 80% of revenues derived from service contracts, the Company places paramount importance on customer retention, boasting an average rate of 85.5% over the past five years. This emphasis on customer loyalty, coupled with its substantial exposure to commercial clients, enables Rentokil to implement price adjustments in line with inflation, safeguarding profitability and enhancing resilience across economic fluctuations.

Route Density

Rentokil's strategic focus revolves around ‘route density’ which aims to increase the number of customers on each technician's route. Increased route density yields benefits such as faster service, improved responsiveness to client needs, spread of fuel cost across more customers and more importantly the capacity to serve more customers. Employee expenses (approximately 50% of revenue) and fuel costs are significantly impacted by route density optimization, consequently, enhanced efficiency results in lower service cost and higher margins.