2023-12-28 05:38:40 ET
Summary
- Rollins is one of the largest players in the pest control industry in the US, with minimal disruption risks and strong organic growth.
- The company has a resilient business model, with 75% of recurring revenues and a market share of roughly 13%.
- Rollins has a strong financial position, with consistent healthy growth, good margins, and minimal capital and working capital requirements.
When we think about long-term investing, one of our main aspirations should be to compound capital steadily over extended periods. This is only possible through good companies, preferably those with low disruption risk. Rollins is one of the largest players in the pest control industry in the United States, an essential industry with minimal disruption risks and some tailwinds that we will discuss later. It's challenging for me to imagine that Rollins won't continue to exist 50 years from now.
Business Model
Founded in 1948. In 1964 happened the first main event, after brothers O. Wayne and John Rollins acquired the Orkin brand, Rollins, Inc. ( ROL ) has become the leading exponent in the pest control industry. With a strategy that combines strong organic growth and acquisitions, Rollins has never experienced a year of negative sales in the last 20 years. It can be considered a resilient and essential business for its customers (It has managed to grow sales at an annual rate of 7% over the last 20 years), as pests are unacceptable in both workplaces and homes. Moreover, compared to the magnitude of the problem it solves, the expense is not very significant, giving it a high pricing power, which we will also discuss later.
Source: Wells Fargo 2023 Industrials Conference
Rollins segments its sales into three main segments, with the termite segment experiencing the highest growth (12.21% 6-year CAGR). However, the Residential segment is the largest, accounting for 44% of total sales. They have 75% of recurring revenue (coming from maintenance style jobs).
Source: author's representationSource: author's representation
In the last B aird 2023 Global Industrial Conference, management stated that the industry is highly fragmented, with approximately 20,000 players and a total size of around $20 billion. With sales of $2.6 billion in 2022, Rollins holds roughly 13% market share. This industry benefits from some tailwinds, such as climate change, which raises global temperatures and increases the proliferation of pests. Additionally, the growing attraction of warmer states in the United States, such as Florida or Texas, expands the number of potential customers in these areas. Nearly 93% of sales come from the U.S., and Rollins is not in a hurry to expand internationally as they believe the American market still offers sufficient growth opportunities.
Capital allocation and business strategy
Rollins is considered a serial acquirer of companies in the sector (they have acquired over 250 companies during the past 20 years, slide 10). In the same conference, they discussed that their acquisitions are not solely driven by potential markets but also by the culture of the target companies. They emphasized the importance of getting to know these companies at conventions and events. If they are impressed by the culture and values, then they consider the possibility of acquiring them. They also highlighted the significance of cumulative knowledge and the value of relationships with people in the industry.
Rollins not only helps protect the brands, customers, and assets of the companies they acquire but also provides them with capital for growth. Additionally, they integrate these acquired businesses into the company's ERP system to optimize operations. It's noteworthy that Rollins chooses to retain regional brands, and having them backed by the top company in the national sector can enhance their visibility and reputation. This strategy allows for a synergistic approach, leveraging both local brand recognition and the strength of being associated with the industry leader. This approach has facilitated Rollins in achieving the following pattern of organic growth combined with mergers and acquisitions ((M&A))
Source: Author's representation
If we look at Rollins' capital allocation, we see that 50% of the free cash flow generated in the last 7 years has been allocated to dividends, and another 54% has been used for mergers and acquisitions (M&A). They have a Net Income to FCF conversion greater than 100%. In 2019, they issued debt for the acquisition of Clark Pest Control, but it did not pose any problems for the company. As of 2022, the debt levels were at -0.08x Net Debt/EBITDA, indicating a net cash position. Rollins' Return on Invested Capital ((ROIC)) before the acquisition was over 30%. Although it has decreased to 24% after the acquisition, it has been growing since 2019 when it was at 19%, reflecting the positive impact of the acquisition on the company's overall performance.
Source: author's representation
Financials
The company's financials are very strong, with consistently healthy (CAGRs) across all figures. It boasts good margins with a slight expansion trend, returns well above the average, a net cash position, and a business with minimal capital and working capital requirements. From a quantitative standpoint, Rollins meets all the criteria one would expect from a well-managed and successful company.
Source: author's representation
In labor-intensive businesses, I always wonder how they can leverage the operation. In the case of Rollins, the focus will be on optimizing SG&A costs, such as IT or HR expenses. They are determined not to cut anything that could harm the satisfaction of the end customer, which speaks highly of their corporate culture. Therefore, we might expect a slight margin expansion, thanks to increased productivity that the company anticipates through the implementation of technology into their routing and logistics systems. This is the advantage of more traditional businesses - technology, far from disrupting them, benefits them.
Author's representation
If we consider the company's future growth, the sales growth pattern is likely to be: 4% from price increases, as management mentioned at the Baird's Global Industry Conference, plus 2% in terms of volume, and an additional 2%-3% due to future acquisitions. If we add to this a slight margin expansion we could achieve bottom-line growth of around 11%. With a dividend yielding 1%, total returns could be around 12%. However, is a multiple contraction possible that could hinder these returns?
Currently, the FCF multiple is at the 10-year average (37X), which appears to be a relatively high multiple even for a high-quality company like Rollins. In an environment of higher interest rates, the question arises as to whether there should be a compression of multiples for such companies. If your answer is no, then you would likely capture all the mentioned growth. However, if the market decides to pay 30X instead of 37X, it would represent a 20% decline in the stock price.
Regardless, in companies where demand is so resilient and recurring, valuing them based on EV/Sales doesn't seem unreasonable. This approach could help minimize errors associated with predicting bottom-line growth (which can be more challenging than predicting sales). By maintaining the average multiple of recent years and assuming no share buybacks, the expected return could be around 8.5%, excluding dividends. While this may not seem very high, the attractiveness lies in the relative safety of the investment, making it appealing to certain investors.
Source: Author's representation
If we want to evaluate it through a discounted cash flow ((DCF)), I would choose to conduct an Inverse DCF to understand what the market is factoring into the current stock price. The market is pricing in an 8% weighted average cost of capital ((WACC)), a 4% Terminal Growth Rate ((TGR)), and a 12% Free Cash Flow ((FCF)) growth. The 12% growth may be somewhat optimistic but plausible. Regarding the discount rate, I prefer using 10%, which would yield a Fair Value ((FV)) of $28 compared to the current $43. However, in such a secure company and industry, I could understand the use of an 8% discount rate. As for the terminal value, I'm not considering growth from acquisitions. I believe a 4% growth (3% price increase + 1% volume) in the long term is entirely feasible. For all these reasons, I rate Rollins as a hold.
Risks
In an industry with so little technological disruption, the greatest risk I see is operational or from a bad acquisition. Paying a high price, not implementing synergies well, or even facing reputational risk after poor service. However, considering that the company has stuck to the same strategy for over 50 years, I view this as a minor and unlikely risk. As I mentioned in the valuation section, I understand that Rollins should be valued using lower discount rates or lower terminal growth rates due to its low operational risk. Although, as we've discussed before, one of the most challenging aspects of these types of businesses is scaling them, given their labor-intensive nature and potential difficulties in finding people willing to work in such industries.
Other important graphs
Drops of more than 25% from the highs have historically proven to be very good entry points.
It has had returns significantly higher than the S&P 500.
The historical multiples may appear high at first glance, but as we've seen, there are reasons behind them.
Conclusion
As we've seen, Rollins is a straightforward business that exhibits all the optimal characteristics for long-term investment: low disruption risk, a high terminal value, a highly fragmented market open to consolidation, good capital management, and enviable financials. Despite all this, I do find the valuation to be demanding, so I'm staying on the sidelines for now. However, as we've also observed, drops of more than 25% are infrequent, making them potentially good opportunities.
For further details see:
Rollins: Very Low Risk Of Disruption