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Is the party over for the portfolio's mainstay?
UK investors will know that with 6-month reporting cycles, we only get to actually see and analyse our company's progress twice a year. It is therefore important to use those few opportunities to see how things are progressing, whether our companies are fulfilling their targets and whether anything has changed about our companies since we first bought them. Today it was the turn of portfolio mainstay and first purchase Rentokil Initial to publish their interim results for the 6 months ended June, and we will cover them in depth. The How To Value shares series will continue on Friday, but if you'd like to recap on parts one to five of that, click here to access the archives.
Rentokil Initial
The aim of this company is quite simple, and despite the danger of boring some veteran Qualiport followers, it is worth repeating.
"Rentokil Initial has an objective to increase profits and earnings per share by at least 20% every year, as long as it is not at the expense of long-term growth."
This objective has been in place, and achieved, in each of the past 16 years -- a truly remarkable performance. Before we look at the results for the 6 month period just ended, it is worth re-focussing on the latter words of the above Rentokil objective. "As long as it is not at the expense of long-term growth."
The Results
Shock of all shocks! Here's the growth numbers at reported exchange rates:
In common with Rentokil's past results days, the shares took a bit of a dive, ending the day down 14p at 365p, having been off 30p earlier in the day as market makers reacted to the less than 20% reported growth. Every time the company reports, analysts doubt whether Rentokil can keep up their remarkable growth record, so the share price usually falls. But the success story has kept coming up until now, so the share price usually recovers its poise in the ensuing months.
The lack of sales growth is worrying, but not entirely unexpected. Here's why.
For the 1997 calendar year, Rentokil grew sales by 23%, pre tax profit by 31% and EPS by 20%. But splitting that out into the 2 halves that make up the year, we see:
6 months to June 97
Again today, it was a big improvement in margins that allowed Rentokil to get anywhere near their objective growth rate. They jumped from 13.8% in the first half of 1997 to 16.0% in the period just finished, up from 15.2% for the second half of 1997, and up from 14.5% for the full 1997 year. This is still a far cry from the 24.6% profit margin the company achieved in 1995, the last period before the BET takeover.
In line with many company's with international operations, Rentokil have been hit by the Strength of Sterling (SOS). They say that, at constant exchange rates, turnover rose by 5.7%, profits by 24.5% and EPS by 25.5% -- not that they are using that as an excuse for their failure to hit their target, but they did feel appropriate to point it out. A company like Unilever primarily reports its underlying progress by using constant exchange rates. It often gives a better feel for how a company is progressing, although investors will need to be wary of the companies who bleat when sterling is strong but keep schtoom when it weakens.
An example of how the SOS is affecting the company is trading in the Asia Pacific and Africa geographic area, where turnover was down a reported 17.5% -- yet taken at constant exchange rates, it was up 6.9%. Obviously the turmoil in Asia is affecting all companies who trade in that region. Of Rentokil's gross sales for the half year of £1,438.3m, only 5% came from the Asia Pacific and Africa region.
Rentokil have been shedding some lower margin contracts, particularly in the US, and this has taken its toll on turnover and profits in that region. This area poses the biggest challenge to Rentokil and makes up 26% of their gross turnover.
The Future
The big question mark hanging over the company in the near term is whether they will achieve their 20% growth aim for the full 1998 year. With EPS of 10.32p in 1997, it means Rentokil will have to achieve 1998 EPS of 12.38p for minimum 20% growth. With 5.63p earned in the first half, that means the target for the second half of this year is 6.75p versus the 5.58p earned in the second half of 1997, or growth of 21.0%. This is certainly attainable, and if I were a betting man, I'd say they'll do it. The second half comparison is less demanding, as we saw above, because sterling in that period was already strong and Asia was beginning to impact on results.
Of course, as long-term shareholders, we should be looking much farther ahead than the next 4 months. Although they are important as far as Rentokil's objective is concerned, in the context of the next 10 years they are relatively insignificant. What the lack of sales growth highlights is that the current Rentokil businesses are arguably reaching their full potential. Sure, there's still some margin improvement to come, but the ultimate driver of above average profits will need to be sales growth. The last two 6 month periods have shown poor sales growth, and with margins probably peaking at about 19% (they are 16% at the moment), sales growth will be required to propel earnings.
Sir Clive reassuringly said today that Rentokil sees no need for a large acquisition for the next two to three years. Remember this was said in the context of the 20% growth objective still being in place. This man has successfully run Rentokil for the past 16-odd years, so you have to believe everything he says. Obviously a cut in local interest rates will benefit Rentokil, as it will a lot of companies, so perhaps he's banking on an easing in monetary policy in the not too distant future to fuel profits growth into the new millennium.
Rentokil will actively target smaller bolt-on acquisitions, and they make many of these each year. However, Sir Clive didn't completely discount a large acquisition, saying that if an opportunity presented itself they would run their slide rule over it, but he certainly didn't feel compelled to buy up big. For those analysts who constantly throw up the names of Securicor Group and Compass, this will be somewhat disappointing news.
Rentokil is a long-term holding for the Qualiport. We're happy with their progress in the past 6 months and confident of management's ability to continue to grow profits at above average rates. I have said on previous occasions that I'd be happy owning shares in a company that consistently grew earnings at 15% per annum, providing I didn't pay an exorbitant price in the first place. Whether we see too much further appreciation in Rentokil's share price in the next year remains to be seen. After all, it has gone up by 40% in the past 8 months, when earnings have "only" grown by 20%. As earnings are the ultimate driver of share price appreciation, that sort of share price growth over a short period just cannot be sustained. However, we're very happy to hang on to our Rentokil Initial shares and leave it up to a quality company and management team to keep growing those profits.
We've recently opened up a new Rentokil Initial message board on the web. Click here to see what's being said about them. Have you got a view? Should they be looking to make that big acquisition earlier than "the next 2 or 4 years?" See you there, Fools.
Bruce Jackson (TMF Googly)
Qualiport Numbers
Turnover +2.0%
Pre Tax Profit +18.4%
EPS +18.8%
The 20% target has been missed! This is the 33rd reporting period (over 16 1/2 years) since the objective was introduced, and only the second time the 20% target has not been achieved. However, rather than admitting defeat and scrapping the very demanding self imposed growth target, chief executive Sir Clive Thompson reiterated that it stayed in place. He did take the opportunity to remind shareholders and analysts that it is an objective and not a forecast. The distinction is important. Pharmaceutical company Zeneca have an objective to grow by 15% per annum, but have fallen short over the past few reporting periods.
Sales +67.5%
Profit +44.2%
EPS +20.3%
6 months to December 97
Sales -2.2%
Profit +21.6%
EPS +20.6%
In the second half of last year, the most recently reported numbers we had until today, Rentokil's sales actually dropped by 2%. The company's proud record was saved by a huge increase in margins, up from 12.3% to 15.2% in that period.
Today's Numbers Date 19/08/98
Day Month Year History
Qualiport (0.91%) (2.54%) 36.18% 39.25%
FTSE 100 0.82% (2.44%) 10.88% 13.43%
FTSE All Shares 0.68% (3.21%) 9.79% 12.10%
Qualiport Stocks
Last Rec'd Total # Security In At Current Change
04/17/98 337 EMAP £11.998 £11.420 (4.82%)
05/11/98 736 MKS £5.604 £5.210 (7.03%)
12/19/98 1565 RTO £2.582 £3.620 40.21%
07/17/98 595 ULVR £6.804 £5.810 (14.61%)
Last Rec'd Total # Security In At Value Change
04/17/98 337 EMAP £4043.37 £3848.54 (£194.83)
05/11/98 736 MKS £4124.37 £3834.56 (£289.81)
12/19/98 1565 RTO £4040.63 £5665.30 £1624.67
07/17/98 595 ULVR £4048.38 £3456.95 (£591.43)
Cash: £67.82
Current Total: £16,873.17