Rentokil Initial PLC
A compounder for sale
Rentokil was established in 1925 by Harold Maxwell-Lefroy, a professor of entomology at Imperial College London. Lefroy had been researching methods to eradicate death watch beetles infesting Westminster Hall at the Palace of Westminster. He and his assistant developed an anti-woodworm fluid called Ento-Kill Fluids. In that same year, he attempted to trademark the name Entokill but, due to existing trademarks, he opted for Rentokil instead, which became the name of his company, Rentokil Ltd.
Rentokil Group plc was listed on the London Stock Exchange in 1969. The company acquired the "Initial" laundry and washroom services business, which was established in 1903. Rentokil Initial now offers a range of services, from laundry to washroom hygiene products. The name "Initial" comes from the practice of marking every towel with the customer's initials to ensure that each customer received their own towels.
In 2006, Rentokil expanded its presence in the US residential pest control market by acquiring J.C. Ehrlich Co, Inc., based in Reading, Pennsylvania. J.C. Ehrlich was the fourth-largest pest control company in the US and the largest privately held company in the sector. Then in 2012, Rentokil expanded its presence on the West coast of the United States by acquiring Western Exterminator Company for US$99.6 million, making Rentokil the third-largest pest control company in the country. In December 2021, Rentokil purchased Terminix for $6.7 billion, and became the largest pest control company in the US.
Until 2013, Rentokil had no clear strategic direction. Management liked the pest control business but it remained a conglomerate with a bunch of disparate businesses. In 2013, the company announced that CEO Alan Brown would step down, and Andy Ransom, formerly the managing director of Rentokil's West region, would become CEO. Andy’s big contribution to the business was focus. Rentokil doubled down on the pest control business - which they recognized as the best business within the Rentokil portfolio with secular growth, good margins, low capex intensity and high free cash flow conversion - to a point where 80% of its revenues now come from the pest control business. Further, during his tenure as CEO, Ransom has focused on enhancing the company's service offerings, improving operational efficiency, and expanding its global footprint.
Since 2013, Rentokil has acquired approximately 300 companies to enhance its existing network in the US and expanded into new markets such as India, the Middle East, and Latin America, with a focus on cities poised for higher growth in the future.
While Rentokil typically does small tuck in acquisitions, Terminix was a big one! The integration of Terminix has been delayed. Initially expected to be completed by 2025, it is now projected to finish by 2026. As can be expected, the market does not like this and is in ‘show me the money’ mode. We think this is a tremendous opportunity to acquire a compounder business operating in an industry with secular tailwinds with opportunities for margin expansion.
We anticipate significant total returns in the coming years as we expect a resurgence in sales growth, improved margins, and an expansion in multiples, all of which could lead to substantial gains over the next 2-3 years.
Here is the composition of the business in 2023:
Out of this, geographically:
60% of EBIT is in the US
20% of EBIT is Europe
11% of EBIT is in Asia and Asia-Pacific
9% of EBIT is in UK & Africa
Out of this, segmentally:
80% of EBIT comes from Pest Control
15% of EBIT comes from Health & Hygiene
5% of EBIT comes from Workwear in France (up for sale)
Compared to its closest peer Rollins, Rentokil is more diversified geographically (Rollins is 92% US) and segmentally (Rollins is 100% pest control). It is much more of an international business that has the potential to do really well if the US dollar weakens and if the rest of the world (ROW) starts doing better than the US. We think this type of exposure has a place in the portfolio.
In this report, we will talk about industry structure, competitive advantages, organic growth, Terminix acquisition and the general path for Rentokil going forward.
Industry and Competitive Advantages
The slide below from Rentokil shows the size, segmentation and growth of the US market (esp residential which is very under-penetrated):
Pest control businesses are benefiting from several secular forces that are driving growth in the industry.
Rising urbanization and population density are increasing the demand for pest control services as more people live in close quarters, creating opportunities for pests to thrive. The US population moving to the Southern US states is a big part of the trend.
Climate change is causing shifts in pest populations and behaviors, leading to new challenges for businesses and homeowners that require professional intervention.
Additionally, heightened awareness of health and safety standards, stricter regulations and reputational risks, are motivating both residential and commercial customers to invest in regular pest control services.
Here is an example of how clients think about pest control,
In commercial pest control and even residential pest control, we all use the same product. Ecolab claims they manufacture their own, but they also sub in plenty of others. It's all about service and responsiveness. Pricing to a certain level, but pricing is not always the number one choice. For a lot of them, it's in the top three, but it's not number one. It's service, it's responsiveness. It's "Getting the information I need because I got a boss I report to in facilities or operations. I don't want to have to explain over and over why we have a pest issue in this one location and why we can't get it under control.
-Former VP at Terminix (Alphasense Transcript)
Importantly, the slide below from Rollins shows just how defensive this industry has been in the past:
Source: Rollins Investor Presentation
Revenues grew through weak economic conditions showcasing the essential nature of these services.
The other advantageous factor about the industry is that Pest control companies benefit from a recurring revenue model that provides them with a steady and predictable stream of income. Rollins and Rentokil often offer ongoing services through subscription plans, such as yearly or multi-year contracts. With these plans, these companies provide regular pest control services to customers such that pests never become a problem.
With these contracts, especially with commercial clients, pest control companies use digital sensors and monitoring devices to detect pest activity in real-time. Advanced pest control systems allow for remote monitoring of traps, baits, and sensors. These devices can alert technicians to infestations or pest presence, allowing for targeted interventions. This is both a service enhancing and a cost saving mechanism for the pest control companies. The end result is that the business becomes more defensive, higher quality, and cash management becomes much easier.
The market fully recognizes this and has awarded Rollins with very high multiples:
For those calculating, Rollins stock price has increased from $1.50 in May 2004 to $8 in May 2014 to $47 in May 2024 leading to a 19% CAGR over both the 10 and 20 year time period. A very impressive track record indeed!
In the United States, the pest control industry is dominated by a few large companies, each with a significant market share and extensive networks across the country. The most prominent of these are Rollins, Rentokil, and TruGreen, Arrow, among others. As we mentioned before, after the acquisition of Terminix, Rentokil has now become the largest pest control business in the US.