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Questor: Rentokil, the former pariah, is now is a fast-growing and focused business: buy
Rentokil, the rat-catching firm, was laid low by the determination of its former boss Sir Clive Thompson to achieve 20pc growth in earnings every year come what may. Ironically, the business is now in sight of delivering that kind of growth – this time in a rather more sustainable fashion.
In the 1990s Sir Clive (“Mr 20 per cent”) built the entire organisation around the idea that it had to improve earnings per share by that amount every year. This led to all sorts of creative accounting and acquisitions, whose essential worthlessness gradually became apparent.
The stock acquired pariah status in the City, Sir Clive was ejected and a new management team set about dismantling the conglomerate he had created and returning Rentokil to its roots as a pest control business.
“When the new chief executive, Andy Ransom, was appointed in 2013, he looked at the group, decided that the core business was the best part of it and set about disposing of the rest,” said Alasdair McKinnon, who counts Rentokil among the top 10 holdings in his Scottish Investment Trust portfolio.
“When we looked at the stock two years ago, we saw that it was on its way to becoming a focused pest control business but that the market was giving it no credit.”
He said this focus was allowing Rentokil to improve profit margins in pest control. “For example, it is adding to its network of sites in Britain. This allows it to service customers with a round trip of, say, 50 miles instead of 100, making its operations more efficient.
“It is adding these sites mostly by buying small existing businesses, which are often owned by families that are looking for an exit. As small, unquoted companies, these outfits can often be bought cheaply, and Rentokil can make further cost savings, for instance in staffing, when they are integrated into its network.”
Rentokil is a very international business – North America and Europe account for 39pc and 27pc of revenues respectively, with 8pc from Asia and 8pc from the Pacific region – but is pursuing the same path of focusing on pest control overseas, although it hasn’t managed to exit all its legacy businesses there yet.
Rat catching has other attractions as a business. It seems immune to digital disruption (although technology such as remote monitoring can make it more efficient) and has proved resilient in the face of economic downturns.
“Pest control firms managed to increase prices by 3pc-4pc a year throughout the financial crisis and we think Rentokil can continue to raise prices by more than the rate of inflation now,” McKinnon said.
“This, along with the small acquisitions it is making, should produce decent growth. In fact analysts expect earnings to rise by double-digit percentages for the foreseeable future.” The shares have risen a long way since McKinnon bought them about two years ago – and since Questor tipped them at 140p in May 2015 – but he believes that there is still scope for further improvement.
This is partly because Rentokil shares trade at a big discount to American peers such as Rollins and ServiceMaster. Rollins, for example, trades at 45 times 2018 earnings. Against this, Rentokil’s figure of 22 does not look demanding, especially given the forecast for sustainable and significant earnings growth.
Another point is that the highly rated US firms might bid for Rentokil as a relatively cheap way to grow their own business and improve margins – via the same kind of efficiency measures that Rentokil itself is currently pursuing.
The company’s return to the FTSE 100 in March this year should also help it to appear on more investors’ radar.
McKinnon concluded: “Rentokil is no longer a turnaround story; it’s recognised as a good company with a very credible plan to deliver margin targets. Despite the recovery in the share price we think there is sufficient scope for further improvement to keep holding the stock, although at some stage we will recycle the capital into new opportunities.
“Sir Clive used the cashflows from the core business to build a conglomerate of questionable quality. Investors don’t allow firms to pursue the same ‘growth at any price’ agenda these days, and the new management is concentrating on maximising value from that profitable core instead.”
Questor says: buy
Ticker: RTO
Share price at close: 293.3p
- All Questor's tips: telegraph,co,uk/questor