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Rollins: The Perfect Time to Invest and Upgrade to ‘Buy’

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Rollins (NYSE:ROL) continues to impress with its latest quarterly results, showcasing an impressive 8.4% organic revenue growth and a 29% increase in adjusted operating income compared to the previous year. In my previous article, I suggested considering buying the stock when it reaches around $33. With the strong Q3 FY23 results and the recent decline in stock price, I am confident in upgrading my rating to ‘Buy’ and setting a fair value of $38 per share. This is an opportune time for long-term investors to start building their positions in this promising compounder.

Q3 FY23 Results and Positive Outlook

Rollins has consistently demonstrated high-single-digit organic revenue growth, with an impressive 8.4% growth in Q3 FY23. They have also expanded their adjusted operating margin by 240 basis points compared to the previous year, resulting in a 29% increase in operating income. This consistent growth aligns with their management’s focus on sustaining high-single-digit organic revenue growth over the past 11 quarters.

Rollins attributes their topline growth to several factors. Firstly, their extensive portfolio of pest control companies provides valuable cross-selling opportunities. Secondly, they utilize various methods such as digital marketing, cross-selling, service bundling, and door-to-door sales to attract new residential customers. Lastly, Rollins strategically invests in acquiring commercial customers in highly profitable sectors such as hospitality, healthcare, and logistics.

It’s worth noting that Rollins’ growth potential surpasses that of the overall pest control market. According to Statista, there are over 34,000 pest control companies operating in the U.S., with Rollins and Rentokil leading the pack. These industry leaders leverage their scale to acquire smaller companies, consolidating the market. Rollins’ investments in route density and digital marketing further enhance their advantages over competitors.

Research indicates a projected 5.2% compound annual growth rate for the pest control market from 2021 to 2025. With Rollins’ strategic initiatives and market position, they are well-positioned to outpace overall market growth.

Rollins has consistently adhered to their long-term capital allocation policy. They have spent $349 million on mergers and acquisitions in the first three quarters, allocated $21 million to capital expenditures, $192 million to dividends, and $315 million to share buybacks. Notably, Rollins maintains a robust balance sheet with negligible debt and a gross debt leverage ratio below 1x.

Rollins’ full-year guidance instills confidence in their organic revenue growth and margin expansion. Their management’s unwavering optimism about the underlying strength of the North American pest control market is a key insight from the earnings call.

Rollins vs. Rentokil: Rollins Leads the Market

Rollins and Rentokil are the leading players in the North American pest control market, actively acquiring small and mid-sized regional players. While Rentokil achieved a 4.1% organic revenue growth in the North American market in the first half of FY23, their growth rate decelerated to 2.2% in Q3 FY23. In contrast, Rollins demonstrated consistent growth, with revenue increasing by 9.2% in Q1 FY23, 7.7% in Q2 FY23, and 8.4% in Q3 FY23. It’s clear that Rollins is gaining market share while Rentokil is experiencing a decline.

Rentokil attributes their slower growth to challenges in new residential customer acquisition, influenced by the macroeconomic backdrop and a softer consumer demand environment. On the other hand, Rollins has excelled in acquiring new residential customers, with their residential business growing by 20% on a constant currency basis. Rollins’ strategic partnerships with prominent home builders have significantly expanded their distribution channels and deepened client relationships.

Favorable Valuations and Strong Growth Prospects

Considering Rollins’ robust year-to-date organic revenue growth, I have revised the organic revenue forecast to 8.5% for FY23. Moreover, acquisitions are expected to contribute an additional 5.5% to topline growth. These assumptions are derived from their average growth rates in the first three quarters. The new valuation model also accounts for a -30 basis points headwind from foreign exchange this year, while all other assumptions remain the same.

Based on the model, I estimate Rollins’ fair stock price value to be $38. With the recent market pullback, there is a compelling opportunity to invest in this high-quality compounder.

Potential Risks and Takeaways

Rollins recently implemented a restructuring program, resulting in $5.2 million in expenses this quarter. This marks the first time in about 20 years that they have executed such a program, aimed at supporting modernization initiatives and streamlining their overhead structure. It is important to note that these costs are excluded from the adjusted operating income calculation.

Readers should recognize that reinvesting these savings back into Rollins’ business is vital for their future growth. The management team has disclosed that approximately 15% of their back-office employees were affected by this restructuring effort. Although layoffs can sometimes raise morale concerns, Rollins remains focused on their long-term goals and sustainability.

Final Thoughts: Invest in Rollins’ Growth

Rollins has consistently delivered high-single-digit organic revenue growth even after the pandemic. Their market share continues to grow, outpacing the overall pest control market growth. I am upgrading Rollins to a “Buy” rating and encourage investors to start building their positions in this promising stock.

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