2023-03-23 01:46:43 ET
Summary
- The Terminix acquisition is exciting for RKLIF as it will provide higher route-density synergies to boost earnings and catch up with Rollins' growth rates.
- The updated synergy target of $200 million for FY25 is achievable as there will be many overlapping locations in their branch office network.
- RKLIF's mid-term goals call for an organic growth rate of at least 5% and an adjusted EBITA margin of at least 19.0% until FY25.
- The current valuation of 23x forward P/E is not very expensive, and RKLIF has the potential to get its valuation re-rated higher if it can execute as guided.
Description
In general, I think Rentokil's (RTO) ( OTCPK:RKLIF ) decision to concentrate on the pest-control market is wise because the sector is expected to grow rapidly both now and in the future. Over the next few years, I anticipate that the pest control industry will continue to consolidate and grow in the low to mid single digits range. The closing of the Terminix acquisition in 3Q22 is particularly exciting for RKLIF. The higher route-density synergies will provide a boost to earnings and also give RKLIF the opportunity to catch up with Rollins' ( ROL ) growth rates. In conclusion, Rentokil is a great company and I am recommending a buy rating on RTO stock.
4Q22 results
I'd like to commend management for sounding so assured throughout the earnings call before we dive into the numbers. The call included crucial information, including specifics on synergies, integration, long-term growth prospects, and the deal itself. Management did not provide any information regarding organic growth for FY23, but they did say that the year is off to a good start and that they anticipate underlying margins will improve as well.
In terms of the results, revenues were consistent with the consensus estimates, and the adjusted PBT exceeded expectations, mainly due to improved synergies. The Group's adjusted EBIT amounted to £571 million, which was 4% higher than the expected consensus, resulting in an implied margin of 15.4%. The Group's organic growth for the full year was 6.6%, with North America exhibiting a growth rate of 5.7%. The organic growth in the fourth quarter for Pest Control in North America improved to 5.6% from 3.5% in the third quarter. FCF was £374 million, which grew by 6% compared to the previous year, and DPS for FY22 were 7.55p. Overall, I perceive the results as sound, as the increase in synergy guidance indicates that the management has effectively executed the deal integration. Additionally, I expect consensus and investors to revise their FY25 targets, as such should push the stock higher.
Industry and growth
From the 4Q22 earnings ppt, data indicates that the global Pest Control market will expand at a CAGR in the mid single digits through 2027, with the United States growing at roughly 5% of and the rest of the world at 6%. More than half of the world market is in the United States, and 65% of the US market is made up of residential and termite treatments alone. The most important thing I learned from this is that the current RKLIF penetration rate among US consumers is less than 15%. It's important to keep this in mind because, although having a smaller share (RKLIF has a smaller US share than ROL) would result in weaker economics, this in no way indicates that RKLIF is lousy business. With a smaller share, it means RKLIF can continue to grow at a faster rate, and true enough management also believes they can grow at a rate that's 1.5 times the US industry average.
Terminix deal and synergies
The previous synergy target of $150 million for FY25 has been increased to $200 million. The updated guide has successfully dispelled my previous confusion regarding whether or not this synergy occurs before or after reinvestments. To be more precise, the goal is to achieve a $275 million in gross synergy, of which $75 million will be used to reinvest in the company. I appreciate management being transparent about this, as I think it will boost investor optimism about the company's long-term margin growth. As for the likelihood of RKLIF achieving this synergy, I find it to be fairly plausible. In my opinion, when these two businesses are combined, there will be many overlapping locations in their branch office network. As full utilization of each office/node greatly improves unit economics, route efficiency is a key factor in the success of this business. On the whole, there are currently 600 branches in North America, but management has indicated they want to cut that number down to about 400 in the future. If we accept these numbers at face value, it means that the combined business will be 1.5 times more efficient than it is right now.
Guidance
The first few months of FY23 have gone swimmingly. RKLIF's pricing structure is robust enough to continue offsetting inflation. Management is anticipating sustained robust underlying trading momentum throughout the year. Until FY25, the company's new mid-term goals call for an organic growth rate of at least 5% and an adjusted EBITA margin of at least 19.0%. Restructuring and higher financing expenses are two examples of what I deemed as one-offs events that will occur in FY23 before returning to normal levels thereafter.
Valuation
The current valuation of 23x forward PE is also not very expensive. Assume RKLIF can meet consensus guidance in FY25, which should be easy if the synergy is successful and RKLIF continues to grow organically. One could also argue that the discount compared to ROL is significant, and RKLIF has the potential to have its valuation re-rated higher if it executes as planned. RKLIF, for example, used to trade at 40x just two years ago. As a result, the possibility of increased upside from valuation re-rating should not be dismissed.
Author's estimates
Summary
All in all, the 4Q22 results were sound, with revenues meeting consensus estimates and adjusted PBT exceeding expectations. The recent Terminix acquisition is particularly exciting, as it will provide RKLIF with higher route-density synergies and the opportunity to catch up with ROL growth rates. The increase in synergy guidance indicates that management has effectively executed the integration, and I expect consensus and investors to revise their FY25 targets, pushing the stock higher. Overall, I recommend a buy rating for RKLIF.
For further details see:
Rentokil Initial plc: Business Is On Track To Grow Faster