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Questor: as a focused rat-catcher, Rentokil is on a roll. But are the shares too expensive?
Questor share tip: the firm has shed its old accident-prone reputation. Now the question is whether it deserves its valuation
Investors with long memories will remember all the shenanigans that have taken place at Rentokil Initial down the years.
What with the defenestration of Sir Clive “Mr 20pc” Thompson, the failed shareholder coup mounted by former Granada chief Sir Gerry Robinson, Colonel Gaddafi’s unpaid rat-catching bills and a parcels arm that never quite delivered, for a time it was more soap opera than sanitation company.
When the shares slumped to barely 30p in December 2008, it felt like even the rats were deserting a sinking ship. But look at it now. Rentokil shares have been a star in a business services sector blighted by the woes of Capita, Mitie and Interserve. In fact, they have risen tenfold in roughly a decade.
The quiet revolution is being led by a pair of ICI veterans, chairman John McAdam and Andy Ransom, the chief executive, who succeeded their third amigo, Alan Brown, when he departed in 2013.
From trying to do too many things, Rentokil has focused back on what it does best: catching rats and other vermin. Thanks to warmer weather, which encourages breeding, many cities are suffering an epidemic. New York’s mayor committed an extra $32m (£24.7m) to escalate his war on rats in 2017 – a tidy sum until you consider that the global pest control market is worth $18bn a year and growing at a 5pc clip.
Analysts at Stifel, the stockbroker, said they were reassured about current market conditions after strong results recently from US rival Rollins, with higher pricing and volumes feeding through in the fourth quarter. Pest control has garnered a reputation for high cash generation and attractive margins.
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Rentokil’s pest control division – which contributes two thirds of group profits and makes 16pc operating margins – grew by an underlying 4pc in the first half of the year. Annual figures are due on Feb 28.
The trick now is to carry on buying small firms to increase coverage in key territories such as America, as well as investing in new technology.
Rat-catching has come a long way from the basic bait box. Now the company has more than 60,000 PestConnect devices installed at customers’ sites. They use infrared beams to sense activity and trap rats and are hooked up digitally to a command centre that crunches data to create risk assessment reports for buildings and other useful analytics.
There is also a bed bug warning system in development for hotels and many patents filed in relation to Lumnia, a new system for fly-catching. After a tour of Rentokil’s innovation centre in West Sussex, analysts at JP Morgan Cazenove, the broker, were convinced that the firm would do better “upselling” its technology-led services than security and cleaning companies have managed.
The remainder of group profits come largely from hygiene – the supply of air fresheners, sanitary bins and soap dispensers – which is growing at about half the rate of pest control but stands to benefit from the drive for cleaner living.
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Rentokil targets annual revenue growth of 5pc-8pc in the medium term, with about half of that coming from existing operations. There were 23 acquisitions in the first half, mainly in pest control. Rentokil monitors 200 targets at any one time and is expected to spend up to £250m a year on deals. It was ordered by the Competition & Markets Authority to sell several large supply contracts as the price for taking control of Cannon Hygiene.
Mr 20pc was famous for delivering stellar earnings growth, although his target was scrapped several years before he left. Perhaps more sustainably, analysts have pencilled in 5pc adjusted earnings growth for the year just ended and 11pc for 2019. It is difficult to see where the downside is.
One concern could be management. One of the architects of Rentokil’s revival, McAdam, is due to retire and Sir Crispin Davis, a fellow board member and former Reed Elsevier chief, is a likely candidate to replace him.
And then there is the share price. Rentokil trades on a whopping 25 times this year’s forecast earnings. It has successfully exterminated memories of past underperformance, but is no longer cheap. Tipped as a Questor buy in September 2017 at 293.3p and again last February, it is time to take profits.
Questor says: sell
Ticker: RTO
Share price at close: 353.1p