2023-10-28 01:10:06 ET
Summary
- Rollins reports strong Q3 FY23 results with 8.4% organic revenue growth and a 29% increase in adjusted operating income.
- Rollins attributes its consistent growth to cross-selling opportunities, diverse marketing methods, and strategic investments in acquiring commercial customers.
- Rollins outperforms competitor Rentokil in the pest control market, gaining market share while Rentokil experiences a decline.
Rollins ( ROL ) has delivered another strong quarterly result, showing an 8.4% organic revenue growth and a 29% increase in adjusted operating income year-over-year. In my initiation article , I encouraged investors to consider buying the stock when its price drops to around $33. Given the robust Q3 FY23 results and the recent decline in stock price, I am upgrading my rating to 'Buy' with a fair value of $38 per share. I suggest long-term investors start building positions in this compounder.
Q3 FY23 Results and Outlook
In the post-pandemic era, Rollins has consistently achieved high-single-digit organic revenue growth, recording an impressive 8.4% growth in Q3 FY23 . Furthermore, their adjusted operating margin expanded by 240 basis points this quarter compared to the previous year, and operating income increased by 29% year over year. This overall growth is remarkable, and it aligns with their management's emphasis during the earnings call on their sustained high-single-digit organic revenue growth over the past 11 quarters.
Their management attributed their consistent topline growth to the following factors. Firstly, their extensive portfolio of pest control companies creates valuable cross-selling opportunities. Secondly, they employ diverse methods such as digital marketing, cross-selling, service bundling, and door-to-door sales to attract new residential customers. Lastly, Rollins has strategically invested in acquiring commercial customers in highly profitable sectors including hospitality, health care, hospitals, logistics, warehouses and distribution centers.
I believe Rollins' growth potential exceeds that of the overall pest control market. According to Statista , as of January 2023, there are over 34,000 pest control companies operating in the U.S., with Rollins and Rentokil (RTO) leading the pack. These major players leverage their scale to acquire smaller companies, consolidating the industry. Additionally, their advantages include route density and investments in digital marketing and platforms.
The Research by Markets projects a 5.2% compound annual growth rate in the pest control market from 2021 to 2025. Given this growth trajectory, Rollins' strategic initiatives position them well to outpace the market.
Regarding capital allocation, Rollins has adhered to their long-term policy by spending $349 million on mergers and acquisitions in the first three quarters. They allocated $21 million to capital expenditures, $192 million to dividends, and $315 million to share buybacks. Notably, Rollins maintains a robust balance sheet with negligible debt and a gross debt leverage ratio below 1x.
In terms of full-year guidance, Rollins expresses confidence in their organic revenue growth and margin expansion. A key insight from the earnings call was the management's unwavering optimism about the underlying strength of the pest control market in North America.
Rollins vs. Rentokil
As mentioned earlier, Rollins and Rentokil are the two largest players in North America's pest control market, and both have been actively acquiring small and mid-sized regional players. In the first half of FY23 , Rentokil achieved a 4.1% organic revenue growth in the North American market. However, this growth rate decelerated to 2.2% in Q3 FY23 . In contrast, Rollins demonstrated consistent growth, with revenue increasing by 9.2% in Q1 FY23 , 7.7% in Q2 FY23 , and 8.4% in Q3 FY23 . It's evident that Rollins is gaining market share while Rentokil is experiencing a decline.
Rentokil attributes their slower growth to challenges in new residential customer acquisition, influenced by the macroeconomic backdrop and a softer consumer demand environment. In contrast, Rollins has excelled in acquiring new residential customers, evidenced by their 20% growth in the residential business on a constant currency basis. For instance, HomeTeam, a Rollins subsidiary, has formed partnerships with over 1,000 home builders nationwide, including prominent names such as Lennar ( LEN ), D.R. Horton ( DHI ), and KB Home ( KBH ). These strategic partnerships have significantly expanded Rollins' distribution channels and deepened their client relationships.
Valuations
Considering their robust year-to-date organic revenue growth, I have revised the organic revenue forecast to 8.5% for FY23. Additionally, acquisitions are expected to contribute another 5.5% to the topline growth. These assumptions are derived from their average growth rates in the first three quarters: 8.4% for organic revenue growth and 5.7% for M&A growth. The new model also accounts for a -30 basis points headwind from foreign exchange this year. All other assumptions remain unchanged.
The fair value of Rollins stock price is estimated to be $38 in my model, and the recent market pullback creates a good opportunity to invest on this high-quality compounder.
Risks
Rollins has implemented their restructuring program, incurring $5.2 million in expenses this quarter. Remarkably, this marks the first time in about 20 years that they have executed such a program, aimed at supporting their modernization initiatives and streamlining their overhead structure. It's crucial to note that these costs are excluded from the adjusted operating income calculation.
I want to remind readers that reinvesting these savings back into their business is vital for Rollins' future growth. The management team disclosed that approximately 15% of their back-office employees were affected by this restructuring effort. While such layoffs can sometimes raise morale concerns within companies, Rollins remains focused on their long-term goals and sustainability.
Takeaways
Rollins has been consistently delivering high-single-digit organic revenue growth after pandemic, and they are gaining market share and outpaced the pest control market growth. I upgrade it to “Buy” rating and encourage investors to start to build up the positions.
For further details see:
Rollins: It Is The Time To Build Some Positions Now; Upgrade To 'Buy'