Ivan-balvan
Investment Thesis
Rollins (NYSE:ROL) is a high-quality company with a strong market position and impressive financial performance. However, its current valuation may limit the potential upside, especially considering the challenges it may face in the near term. While the company’s capital-light structure and recurring revenues are attractive, valuation suggests a “Hold” rating for now. Investors should closely monitor Rollins for potential entry opportunities when its price-to-FCFF ratio falls below 40x, considering the long-term growth prospects and market dynamics.
Company Description
Established in 1964, Rollins (“the company”) offers, through company-owned and franchised locations, pest and wildlife control solutions and protection against termite damage for residential and commercial customers. Rollins operates, primarily in the United States, under one reportable segment comprising three core business lines:
- Residential: Providing pest control services to safeguard residential properties.
- Commercial: Offering tailored pest control solutions for various industries such as healthcare and food service.
- Termite: Delivering termite protection services to both residential and commercial clientele.
At the core of Rollins’ mission is the commitment to:
Keeping Pests Around the World at Bay
Business Performance
Rollins is a capital-light (i.e., EBITDA factor of 1.17x TTM) business, that delivered an average ROCE of 27.7% over the last four years, an outstanding number in both absolute and relative terms (i.e., it is well above the S&P 500 one of 18.0% 2023A).
Author’s Estimates
Income Statement
Over the last 5 years, the top line experienced a CAGR growth of 10.3%, above the market growth of ∿ 6.72% resulting in a gain of market share from approximately 9.0% to 10.3% relative to its total addressable market, namely the US Pest Control Services. I decided to use the US market as a reference rather than the global one, given that over 90% of the company’s revenues are derived from the US.
Statista
The increase in market share was the result of both organic growth and acquisitions, with one of the most notable recent acquisition being Fox Pest Control. This fast-growing player is already contributing positively to the company’s top and bottom line, as highlighted during the 3Q23 earnings call:
We realized a 150 basis point improvement in gross profit margin as pricing more than offset inflationary pressures… Fox was accretive to gross margins by about 30 basis points.
Rollins Presentation
On the margins side, the picture is even better.
Author’s Estimates
The chart illustrates consistent margin growth in the business, attributed to a positive price/cost equation (with price hikes surpassing input inflation), accretive acquisitions, and cost-cutting initiatives. However, I believe that in 2024E, margins may face pressure due to increased customer acquisition costs (such as advertising expenses), settlement costs associated with auto incidents, and potential resistance from customers regarding pricing adjustments.
Balance Sheet
The balance sheet is robust, boasting an Interest Coverage ratio of 51.46x TTM. However, there is a noteworthy increase in the cash conversion cycle, standing at 23 days TTM, surpassing the historical four-year average of 18 days. This is primarily driven by a higher payables turnover, currently at 11 days compared to the historical four-year average of 15 days.
Author’s Estimates
On the performance front, ROA surpasses the historical norm and currently stands at approximately 17.2%. Meanwhile, ROE hovers around 34.6%, surpassing the cost of equity at approximately 7.8%. The current ROE significantly exceeds the 4-year historical norm of 30.7%, primarily driven by improvements in net margin and, to a lesser extent, by financial leverage. However, in the chart above, we can observe a divergence between EPS and ROCE, indicating that the returns on new investments the company is receiving are lower. However, this is not yet a cause for significant concern.
Cash Flow Statement
The business is cash-flow generative with a current FCFF margin ∿of 14.8% TTM, slightly above the 5-year average of 14.5%.
Author’s Estimates
The cash conversion stands at ∿107.3% (vs 5-year average of 114.2%), CFO-to-Net-Income at 1.22x (vs the 5-year average of 1.38x), and FCFF yield at ∿2.0% TTM. In my opinion, the business’s cash flow profile is highly attractive due to its capital-light structure (working capital + CapEx). However, the current FCFF yield makes it less appealing compared to the S&P 500 (SPX) median FCFF yield of ∿ 3.7% 2023A.
Valuation
Rollins trades at a P/FCFF of 45.84x, significantly higher than the sector median P/FCFF of 12.76x and notably above its closest peer, Rentokil Initial plc (RTO), which trades at a P/FCFF of 14.90x TTM. Consequently, Rollins has been assigned an F-Quant Rating, indicating a very poor score.
SeekingAlpha.com
Meanwhile, from a historical perspective, we have the following.
In my view, the company is not particularly attractive because the potential for multiple expansions is limited. Additionally, on the fundamental side, the outlook for 2024E is likely to be challenging due to potential pushback from customers regarding pricing and increased company spending aimed at driving future growth. I would consider buying opportunities only when the P/FCFF falls below 40x.
Risks
In my opinion, the following can represent potential headwinds:
- Potential strategic missteps from the newly appointed CEO could lead to “diworsification,” impacting efficiency and profitability.
- Pushback on pricing from customers, with limited opportunities for further increases.
- Cold weather conditions, which could negatively impact pest activity and consequently Rollins’ business performance
- Competition, particularly from Rentokil.
Final Remarks
Rollins is undeniably a high-quality company, characterized by a capital-light structure, recurring revenues, and exceptional performance on its investments. However, the valuation suggests that it is not appealing either in absolute terms or relative to its peers. Looking ahead, I perceive more risks than opportunities, particularly when considering the current valuation. Consequently, despite the undeniable quality of the business, I am hesitant to invest in the company at this time.
In my opinion, while there are opportunities for further upside, they are limited. Therefore, I assign a “Hold” rating, indicating a decision to pass for now. However, I will continue to closely monitor the company and reassess for potential entry.
