Rollins: Strong Q2 But Questionable Valuation
Summary
- On July 28, ROL presented its Q2 results, with revenue and EPS coming above the consensus estimates, thus bringing the count of consistent quarterly revenue surprises to 9.
- Total Q2 revenues were up by over 15% to $638.2 million, largely driven by growth in two lines that account for most of the sales: commercial and residential.
- 2021 has been a challenging year for the company, as the share price has been riding a bumpy rollercoaster.
- ROL is exhibiting characteristics of a growth stock trading at a huge premium both to the industry and to the peer. But is it worth overpaying? My answer is no.
- Last year, I said the stock might be considered if EV/EBITDA dips below 30x, and I still think it might be worth considering with the multiple in the twenties. But now, all things considered, ROL is a Hold.
There is no doubt that Rollins, Inc. (NYSE:ROL) is a great company, almost recession-immune as termites and other annoying pests do not take recession breaks, with a successful inorganic growth strategy, copious cash flows, and a strong balance sheet with single-digit Debt/Equity and negative net debt.
But the problem with it is not rare in capital markets: it is expensive and has always been such. Does an industrial, environmental services company that is forecast to increase its revenues with single-digit rates, mostly relying on acquisitions, deserve an EV/EBITDA ratio in the mid-thirties? That is a question an investor should answer after conducting her or his own due diligence. I personally have not considered ROL either as a short- or long-term investment and I will likely not consider going long in the near future. Its 0.7% yield is also anything but appealing which makes the stock an avoid for income investors, while I also cannot pin hopes on its DPS growth story and the yield-on-cost expansion going forward given the inorganic growth is the top priority and the best use of cash for it rather than shareholder rewards.
2021 has been a challenging year for the company, as the share price has been riding a bumpy rollercoaster, Hedgeye called its frothy valuation into question (though it seems the idea has been unsuccessful for now), and the SEC investigation (discussed on page 21 of the Form 10-Q) has also been fraying investor nerves.
Given the stock has a too-lofty valuation, I would opt for a neutral stance.
Now, let us take a deeper look at its 2Q21 results.
The top line
On July 28, ROL presented its Q2 results that were better than the Street anticipated, with revenue and EPS coming above the consensus estimates, thus bringing the count of consistent quarterly revenue surprises to 9. The market was overall happy with this; as a consequence, the share price inched higher, clinching a 5-day gain of around 1.1% as of July 30.
But should investors be truly happy with Rollins' 2Q21 performance? In short, mostly yes. The revenue growth trend continues, while the bottom line is also improving steadily despite inflation that has been one of the primary themes on Wall Street this earnings season. The only disappointment is that the half-year net operating and free cash flows weakened since the inflow from changes in working capital was lower if compared to 1H20 while the half-year net income rose steeply mostly because it was bolstered by one-off, non-cash net gain on sale of assets that obviously had no impact on cash flows. Anyway, ROL still ended the first six months of 2021 with a cash flow surplus even after covering all investing activities.
Total Q2 revenues were up by over 15% to $638.2 million, largely driven by growth in two lines that account for most of the sales: commercial and residential. As shown on page 8 of Form 10-Q, the first line noticed an over 17% increase to $293 million and above 14% in 1H21. Commercial grew at slightly weaker rates both during the quarter and the half-year period, reporting a 13.6% and 10% growth, respectively. Regarding geographical segments, ROL disclosed a 14% 2Q21 and close to 12% 1H21 sales increase in the U.S., its key region that accounted for over 92% of the half-year revenues. It is also worth understanding that ROL had a rather busy 1H21 in terms of acquisitions as 18 deals were closed "through the end of Q2", according to the company's interim CFO who mentioned that figure during the earnings call. The cash flow statement shows that deals closed during 1H21 cost the company $28.4 million, around two times less than in 1H20. In addition to inorganic growth, another driver that bolstered the top line were price increases that, as the Vice-Chairman clarified, added "about 1%."
Apart from that, it seems ROL has easily weathered the pressure stemming from inflation, as its operating margin even improved, from ~19% in 2Q20 to 21% in 2Q21.
Now, I would like to bring a bit more color by comparing ROL's 1H21 with its peer.
There are not that many heavyweight pest-control companies that operate globally. As mentioned on page 5 of the annual report, one of Rollins' major competitors is Rentokil Initial (OTCPK:RTOKY), the constituent of the FTSE 100 currently valued at around £10.5 billion. It is worth remembering that the company is not a pure pest control player and has three reporting categories: Pest Control, core Hygiene, and Protect & Enhance (France Workwear, Ambius, UK Property Care, and Dental Hygiene Services). The company also generates most of its revenues in North America but its footprint globally, and especially in Europe, is far more significant than ROL's.
Rentokil has also published its 1H20 results recently, so we have a plethora of data to compare. First, what are the revenue growth rates? Overall, Rentokil's 1H21 total ongoing revenue at actual exchange rates rose by 13.6%, while at constant rates, the improvement was 18.3%. Organic revenue growth was 11.7%. At the same time, its Pest Control segment posted an 18.7% increase in sales (8.7% organic). As you can see, these results are almost in line with Rollins. Besides, Rentokil is also fairly active on the inorganic growth front; the firm said it completed 24 acquisitions during the first half of the year, 21 of which were in the PC segment.
All things considered, for ROL, the quarter was truly robust in many senses, but its revenue increase was weaker if compared to the PC segment (12.7% vs. 18.7%) of its peer.
But is ROL properly priced? If not, is it worth overpaying?
Valuation is a gnawing concern, as it has always been
In my article from August 2020, when I covered ROL for the first time, I attempted to figure out the rationale behind the market pricing the stock so richly. There were a few reasons I found rather plausible. First, the company is highly efficient given its Cash Return on Total Capital was 30% as of end-June 2020 and above 37% at the moment (as the debt shrank), which is phenomenal. Second, it has been consistently growing, with a 7.7% 5-year revenue CAGR back then and 8.5% now.
But let us look at its valuation once again. To gain an understanding of how its growth rates and multiples compare to the industry and the sector, we can use the Quant screener.
First, I filtered out the U.S. mid-cap and large-cap players from the environmental and facilities services industry of the industrial sector. ROL has the highest forward revenue growth rates in this cohort, 8.2%. 3-year and 5-year rates are also the highest, in high-single-digits.
Its forward EBITDA is anticipated to expand by almost 14%, which is again the strongest result. 3-year EBITDA growth is a bit weaker, thus ROL is in third place here. Now let us look at the multiples. EV/EBITDA (Last Twelve Months) is staggering, 36.7x. 8.3x EV/Sales also raises eyebrows.
Source: Seeking Alpha
But if we take a look at the mid-cap and large-cap echelons of the industrials sector, ROL's 3-year revenue growth rate of 9.4% is not even close to the top ten, it is in 37th place, while its 8.2x EV/Sales is in 17th place. So, ROL has an F value score.
And finally, Rentokil Initial is trading at 17.8x Forward EV/EBITDA, while revenues are anticipated to grow in single digits in the medium term. It has a similar EBITDA margin, 19.8% vs. ROL's 22.7%.
Final thoughts
In sum, Rollins' second quarter was overall successful, as both revenue and profits improved, while margins were strong.
ROL is exhibiting characteristics of a growth stock trading at a huge premium both to the industry and to the peer. But is it worth overpaying? My answer is no. Last year, I said the stock might be considered if EV/EBITDA dips below 30x, and I still think it might be worth considering with the multiple in the twenties. But now, it is too risky, and its price can be reset at any time if a downside catalyst powerful enough emerges, especially given the SEC investigation adds to risks. All things considered, ROL is a Hold.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (9)
EPA-labeled and effective against multiple coronavirus strains
On EPA’s “List N” of products for use against the coronavirus that causes COVID-19
Label assures 100% disinfection of hard, non-porous surfaces and sanitization of soft, porous surfaces.
Can be applied to soft surfaces as well, unlike many other disinfectants
Eco-friendly and lowest EPA toxicity rating
Our customers’ spaces will be dry and usable again within 15-30 minutes