Qualiport

Rentokil - The Final Countdown, Pt. 1
Friday, November 28, 1997

A Qualiport Investment Opinion by Bruce Jackson (TMFGoogly)

Before we get to the final decision about Rentokil Initial, I thought it would be a good idea to do a summary of the relevant numbers and criteria. I'm going to unashamedly steal the format that Randy and Jeff are using for their Drip Portfolio analysis of food companies. It will be split over 2 installments, the first one today, the next on Monday.

Description: "Rentokil Initial is an international service company whose consistent objective is to provide its shareholders growth of at least 20% per annum in profits and earnings per share, whilst not distracting from long term growth prospects." This is a straight quote from the company's 1996 Annual Report. The business is split into 6 divisions:

• Hygiene & Cleaning
• Plant & Distribution
• Security Services
• Property Services
• Personnel Services
• Pest Control

Major Brands: Rentokil for pest control, security and tropical plants. Initial for hygiene, cleaning, personnel services and plant services.

Core Moneymaker: In profitability and turnover terms, Hygiene & Cleaning is by far the biggest of the divisions. Of the company's 1996 pre tax profit of £318m, that division contributed £129.6m, or 40.7%. As a reminder, the Hygiene & Cleaning division includes the Initial branded washroom hygiene services. Next time you're in the loo, take a look around and see if you can spot the Initial brand and logo. The next biggest division is Plant & Distribution with profits of £67.6m, or 21.3% of the company's pre tax profit.

Valuation & Growth: Rentokil Initial have fulfilled their stated aim of 20% growth in profits and earnings per share for the last 14 years in a row. Although analysts are currently forecasting growth of less than that figure for the next 2 years, I think it's safe to say that the company will confound the critics and achieve their growth target. With 1996 trailing earnings per share of 8.57p and a share price of 250p, that has Rentokil Initial trading at a price earnings ratio (p/e) of 29. This is well above their future growth rate.

Using the most up to date information we have available, we can work out the trailing EPS up until 30th June 1997. This comes from the company's 1997 Interim Report. In the US you'd have this information at your fingertips. Here, we have to get the old abacus out.

EPS

12 months to 31/12/96 (from 1996 Annual Rpt):    8.57p
less 6 months to 30/6/96(from 1997 Interim Rpt) -3.94p
equals 6 months to 31/12/96                      4.63p
plus 6 months to 30/6/97(from 1997 Interim Rpt) +4.74p
equals 12 months to 30/6/97                      9.37p

Rentokil Initial's p/e based on trailing EPS of 9.37p is 26.7, still above their stated future growth rate of 20%. The current 1997 full year EPS consensus forecast stands at 10.3p, giving growth of 20.2% based on 1996 EPS of 8.57p. The Hemmington Scott site has 8.91p as the normalised 1996 EPS, which gives growth of 15.6%. On these figures it appears Rentokil is not going to meet its stated 20% growth target. Shock, horror, mark down the shares. Sell, sell, sell.

Hang on a minute. Although for most companies we would usually take the normalised EPS as the base when calculating growth, for Rentokil Initial this is not appropriate. When the company states that its aim is to grow earnings and profits by 20% per annum, it doesn't add to that statement "and oh, by the way, that growth will be based on normalised profits after adding this, subtracting that and removing the other."

Some years Rentokil will have exceptional losses, other years they will have exceptional gains (as they had in 1996, which gives them the higher normalised EPS of 8.91p), but the swings and roundabouts will even themselves out. Fool UK applauds Rentokil Initial for being consistent and for taking into account all costs of running the business every year when applying their growth target.

Interestingly, the current consensus EPS forecast for 1999 is 12.2p, which is growth of 18.4% over 1998's forecast of 10.3p. It seems analysts, as ever, seem to doubt Rentokil's ability to deliver their stated growth target. Sir Clive Thompson will derive great pleasure from proving them wrong yet again.

On Monday, we shall continue the Rentokil summary. In the meantime, please post your thoughts in the Qualiport message board.

Bruce Jackson (TMF Googly)