Rentokil - an update

How clueless is the management team?

In June 2024, we conducted an in-depth analysis of Rentokil when its stock price was near the current level. Shortly after, Nelson Peltz took a stake in the company and the ex-CEO of BT sparked speculation about potential interest from private equity firms. Adding to this, Rentokil's management presented an upbeat outlook in their interim report, expressing confidence in the company's performance for the second half of the year.

As an example, the CEO, Andy Ransom made the following statements in July:

“We've also made progress in colleague recruitment and in particular in colleague retention, where in the year to June, our global colleague retention rate has increased by an excellent 4.2% to almost 86% and by 1.7% year-to-date.”

“I'm very encouraged by the initial progress, and as I mentioned earlier, we are now seeing the green shoots coming through with good progress against the core growth KPIs. Our RIGHT WAY 2 growth program continues in the second half with the announcement of additional investment of $25 million, $15 million of which will be spent in the second half, and which will be spent on digital marketing, extending the brand campaign and adding additional new area sales managers, and importantly, on a series of customer retention initiatives.”

-CEO, Andy Ransom (July 2024)

Ok good. Thesis on track!

It was surprising then when, last week, management came out and gave the following update:

“Whilst we saw some positive momentum in North America sales activity at the end of the second quarter, the trading performance in July and August was lower than expected, and we now expect North American organic revenue growth in the second half to be in the region of 1%.”

-CEO, Andy Rancom (Sept 2024)

So, at the end of July he did not know that things are bad when he conducted the interim conference call but then in September, they do a non scheduled update and say that July was not as good…

The conference call following the profit warning was filled with convoluted corporate jargon. Given that English originated in the UK, it's no shock they excel at crafting such language. However, listening to the call made it clear that the management seemed disconnected from the actual state of the business. The market shared this sentiment, leading to a 25% drop in the stock price.

We spent a few hours on Reddit reading feedback and talking to technicians. We believe the profit warning is a combination of:

• Technicians/sales people have had a lot of change and uncertainty especially with respect to the new pay structure. They don't like this uncertainty when it comes on the heels of constant uncertainty and management changes before Rentokil acquired Terminix.

• There was a fair bit of churn in the beginning and technicians that have left have formed their own pest control businesses or have joined smaller shops in their area. They probably took some clients and have poached more since.

• It also sounds like the bigger national companies (RTO, ROL) have pushed pricing a LOT and these locals are offering cheaper services. You wonder if at these price levels even unoptimized/lower density routes for locals have enough profitability. 

• Some technicians have been pushed to do 20-25 sites per day in the name of efficiency. While this is density/route optimization, the incentive for the technician is to sometimes do a rushed job which helps nobody in the short term and tarnishes the brand in the long term.

These are not easy problems to fix!

This implies that the earnings for Terminix have to be reset lower and Rentokil, in hindsight, paid a very high multiple for this acquisition as the EBITDA at acquisition was essentially not real.

The good here is that,

• The other parts of the business are doing well

• US is still growing but just a lot less than the 5-6% growth of the market

  • A lot of time has passed since the acquisition and business that had to go out the door probably went out the door by now

• US is 60% of the business due to which any negative surprises in this business are not terminal to Rentokil (pun intended) as there is still 40% of the business (EU, international) that is doing well. All EV is not threatened.

  • Even within the US, the commercial business of Rentokil is doing well and the problems seem to be in residential and termite

Importantly, we are back to 10x EV/EBITDA and 17x EPS. These are below average multiples for a better than average business. This management or another management will be able to figure this out and we believe the worst is priced into the stock.

However, this likely takes longer. Investors pay a high multiple for high ROIC businesses where they have high visibility. We do not have that with this business right now and it likely takes a few more quarters before the management gets control of the business and are able to correctly identify and solve these problems.

PS: Great resource: https://www.youtube.com/@POTOMACTV

Here is the original report:

Disclosure: The author and the accounts managed by the author hold shares in Rentokil. This article is for informational purposes only. We may be wrong in our analysis and encourage all readers to come to their own conclusions.