With the focus on pest control and hygiene, I believe there’s plenty of scope for the Rentokil Initial (LSE:RTO) business to grow. The question is, would I buy? Let’s look at the investment case.
On the plus side, the world is becoming more hygiene-conscious, not only the West, but also emerging markets, and pest problems (from moths to mice to bed bugs) are also growing.
When I first started researching this company, I noticed its share price has been on an upward trajectory for the past eight years and felt encouraged that this reflects the market potential and powerful reputation of the brand.
Rentokil Initial’s customer base is as varied as it is large. From the individual who wants rid of a flea infestation to the hotel eradicating bed bugs, plus hospitals, prisons and restaurants. You name it, Rentokil has it covered.
Along with the pest control ops, the Initial business supplies hygiene solutions, workwear, personal protective equipment and specialist cleaning to the pharmaceutical and healthcare sectors. You may have seen its No-touch washroom accessories appearing in public areas in recent years. Initial is heavily investing in this technology, complementing its hygiene strategies.
So far so good and having dug a little deeper into its operations, I expect continued growth. However, I have also come across some red flags, which make me wary of how this FTSE 100 stock will perform.
Acquisitions and legal wrangles
After the successful acquisition of 42 smaller pest control businesses in 2018, the Competition and Markets Authority (CMA) challenged Rentokil Initial over its acquisition of Cannon Hygiene. The CMA found that the merger would reduce the choice of suppliers available to customers of washroom waste removal and ordered Rentokil to sell the contracts that Cannon had brought in before the merger.
In February’s final results, the firm said these contracts represent a small part of the acquired business. I imagine this will reduce the acquisition-linked revenue, but it’s unclear by how much.
Now the CMA is again investigating the company over its completed acquisition of MPCL (formerly Mitie Pest Control Limited). This issue is ongoing. But in 2019’s first quarter, growth continued as the company continued its M&A mission, signing four deals in Pest Control and four in Hygiene.
Rentokil Initial’s market cap is £7.3bn. Earnings-per-share (EPS) was negative in 2018 at -5.3p, compared with 37.21p in 2017. This negative EPS has likely affected the price-to-earnings-to-growth ratio (PEG), which is a very high 3.7, suggesting weaker long-term growth prospects.
But the EPS plunge was due to asset disposals in 2017, amounting to a one-off profit of £449m. Then in 2018, it was subject to a pension settlement charge of £341.6m. This was one of the largest moves ever undertaken in the UK, eradicating pension liabilities from the balance sheet on completion (expected 2020) so future investments can focus on delivering profitable growth.
2018 dividends rose 15% to 4.47p from 3.88p the year before and the dividend cover was almost 3, so cash flow covers this easily. The dividend yield of 1.11% seems low, but it’s better than the nothing that I’d get from some sector peers.
Although there are concerns Rentokil Initial may be overvalued and I don’t advocate ignoring the ongoing legal challenges, I see many reasons for this company continue to thrive. So would I buy? Maybe I’ll wait and buy on a dip.
Kirsteen has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.