Rollins Stock: The Price Has Gotten Ahead Of Itself (NYSE:ROL)

Introduction

Rollins, Inc. (NYSE:ROL) sells pest control products and services to commercial and residential customers. The pest control market is surprisingly profitable and growing market, with the industry set to grow well-above GDP for the next decade. Benefitting from long-term tailwinds as well as a fragmented market, Rollins has emerged as a market leader in the industry and has a track record of delivering strong returns to shareholders. However, despite a positive outlook, Rollins’ valuation has gotten ahead of itself as shares now trade above 40x forward earnings at double the valuation of its closest competitor. With more M&A required to move the needle in order to maintain its growth rate, which gets more difficult to do with size, Rollins has started to overpay for acquisitions as private equity bids up prices. In this article, I’ll dive into the latest company results, provide why outlook for the company, and explain why I’m avoiding shares of the company today.

Company Overview

Rollins is a provider of pest and wildlife control services, primarily in the United States, but also internationally in over 70 countries, selling to both residential and commercial customers. It operates under several brands including Orkin, Fox Pest Control, HomeTeam Pest Defense, Critter Control Wildlife, Western Pest Services and Northwest Exterminating, among others.

On the residential side, the company provides pest control services for rodents (eg. rats and mice), insects (mosquitos, spiders, bed bugs, and ants) and wildlife (birds) that can be a nuisance for homeowners both inside and outside the property. The residential segment of Rollins’ business accounts for 46% of the company’s total sales and is its largest segment.

For the commercial side of Rollins’ business, the company sells to various end markets including healthcare, foodservice, and logistics to help ensure these business run smoothly and operate safely. With over three quarter of the segments sales being contractual and recurring, this provides an element of predictability and stability to the company’s revenue. The commercial segment represents 33% of the company’s total sales.

Finally, Rollins also breaks revenue down into a third segment for termite and ancillary services, where it sells to both residential and commercial customers selling termite protection programs like liquid treatments, foam applications, and termite baiting and wood treatments. This segment accounts for the remaining 20% of sales.

Background

Shares of Rollins have delivered handsome returns to long-term shareholders over the past decade. In the last ten years, including dividends, the company’s shares have delivered a total return of 492% compared to the S&P500’s return of just 239%. On an annualized basis, this equates to a CAGR of 19.5% for Rollins, outpacing the S&P500’s CAGR of 13.0% over the same period.

While the EV/EBITDA multiple has expanded from 18.5x a decade ago to 28.1x today, a good portion of Rollins’ share price returns have been as a direct result of the company’s financial performance. For example, over the last decade, revenues and EBITDA have compounded at CAGRs of 8.7% and 11.6%. And over the last 20 years, the company has grown revenues at 7.9% per year and EBITDA at 11.5% per year (source: S&P Capital IQ). With the CAGRs for the ten year period being very similar to the twenty year period, this demonstrates that the company’s growth rate has not slowed in recent years. Moreover, Rollins has also experienced margin expansion as a result of EBITDA growth outpacing the company’s sales growth.

Organic Growth Outlook

When we consider what’s been driving the company’s growth, historically, it’s been a combination of organic and inorganic growth. Historically, the North American pest control services market had been growing at a 6.5% CAGR from 2018 to 2022, slightly above the U.S. GDP growth rate over this time period of 2.6%. In the next ten years, it’s predicted that the market for pest control services will grow at a 7.3% CAGR. With Rollins 8.2% on an organic revenue basis for 2023, the company seems on track to meet the industry’s long-term growth outlook.

What’s expected to drive this growth? Factors like long-term migration from rural to urban areas has been one of the main factors. For example, as populations (particularly in developing countries) congregate in more urban areas that are more dense, the adoption of health and hygiene increases, which bodes well for the products and services that Rollins sells.

In addition, because dense populations allow for pests to thrive in more urban areas, governments around the world have become more strict about pest control, especially in healthcare, agriculture, and foodservice industries. The COVID-19 pandemic has only accelerated this trend.

Another factor driving this growth is climate change. Over the last few decades, global temperatures have been rising, which has made several insect pests that were more prominent in tropical and subtropical regions to move father north into more temperate regions (like much of the United States). This has consequences for both residential and commercial customers of Rollins, as it means that consumers are battling new pests they might not have otherwise have had to deal with climate change.

Warmer temperatures across the globe has also meant greater food insecurity as global weather patterns change, which allows rodents, ticks, and other pests to have longer breeding seasons and greater opportunities to repopulate and exacerbate problems. Moreover, the increased frequency and intensity of extreme weather events associated with climate change, such as hurricanes and floods, create ideal conditions for pest proliferation and spread, supporting Rollins organic growth. With these long-term tailwinds, even without factoring in any market share gains, Rollins should continue to grow around 7-8% organically, just as it has historically.

Recent Results

In Rollins latest Q4 and full year 2023 results, the company announced revenues of $754.1 million for the quarter, up 14.0% on a year over year basis and beating analysts’ estimates modestly by $0.7 million. EPS came in bang on target at $0.21 for the quarter.

For the full year 2023, Rollins had revenue come in at $3.07 billion, which was also 14.0% higher compared to last year. A good portion of this was related to acquisitions, particularly in the commercial segment of the business. Excluding revenues from acquisitions, revenues would have been up 8.2% on an organic revenue basis, which was in line with what we should expect for long-term organic growth.

Moving down the income statement, Rollins continued to experience margin expansion despite higher costs. With an adjusted operating margin of 19.7% for the full year, the company had 150 basis points of margin expansion with operating income climbing 22.5%.

With respect to the Rollins’ acquisitions, acquisitions represented about 6% of total company revenues for 2023 with 24 total acquisitions during the year. The largest of these was the company’s purchase of Fox Pest Control, a deal the company did for $350 million and was the second largest M&A deal in the company’s history. At a multiple of 18.0x EBITDA, the deal is likely a good fit in my view and management has noted that they’ve already begun to exceed targets post-acquisition.

To me, the potential for cost synergies given the other pest control businesses under the Rollins umbrella, like HomeTeam in particular, is very likely to translate into higher sales growth and expand the company’s geographic reach, given Fox Pest Control’s presence in the northeastern United States. On the earnings call, management noted that this has been underserved market by Rollins so the deal should allow them to transition successfully into the region. In addition, as the 13th largest pest control company in the U.S., it’s good to see Rollins continue to roll-up what still is a very fragmented industry.

Regarding the company’s balance sheet, Rollins’ has a financial profile that’s second to none. At year end, there was just $490.8 million long-term debt, most of which falls under the company’s credit facility. The company also had some lease liabilities of $325.6 million ($92.2 million of which is current). With $103.8 million of cash , this brought the company’s Net Debt to EBITDA ratio to 0.7x, indicating that the company has significant room to take on more debt, should it choose to, if M&A opportunities present themselves.

With excess cash flow after reinvesting back into the business and some M&A to supplement organic growth, Rollins has been consistent in providing regular dividend increases to reward long-term shareholders. With over 34 years of consistent (and often growing) dividends, Rollins pays a bit less than half of its EPS as a dividend, along with occasional share buybacks, as shown by the graphs below.

Valuation

At present, there are 7 analysts who cover Rollins’ stock, 5 of which have ‘buy’ ratings with the other 2 analysts having ‘hold’ ratings. Collectively, the analysts have an average price target is $48.00, with a high estimate of $52.00 and a low estimate of $42.00 (source: TD Securities). From the current price to the average price target one year out, this implies just 4.7% upside, so despite the majority buy ratings, there doesn’t appear to be substantial near-term potential and the stock is likely fairly valued in the eyes of the analyst community.

In my view, I think Rollins’ valuation makes it hard to justify a buy rating on the stock as shares are likely overvalued. Pest and wildlife control is a business that’s relatively impenetrable to external market forces and is unlikely to be disrupted anytime soon. That said, at 28.1x EV/EBITDA and 51.6x P/E, it makes it hard to make a compelling buy case when even the most bullish analysts are projecting an average of 8% sales growth per year into 2026 (source: Bloomberg).

In my view, with long-term organic growth of 7-8% (in line with the industry growth expectation), plus 2-4% of growth related to acquisitions (as has been consistent with history), Rollins should be able to grow 9-12% a year for the foreseeable future. But even assuming the company is able to expand EBITDA margins 50 basis points a year, it makes it hard to justify such lofty multiples at 45.7x forward earnings, even for a company with a high quality business model.

In recent years, a tremendous amount of private equity money has flooded the space, pushing up valuation multiples Why? The pest control business has all the attributes private equity loves: a predictable business model, a fragmented industry, high margins and free cash flow, and re-occurring revenues (particularly in the faster growing commercial side). That said, despite great attributes, I think the expensive multiples put on these businesses has meant that the future returns are likely to be sub-par going forward. For an acquisitive company like Rollins, this likely means that the company may have to start paying up for deals if it wants to compete in the M&A space. It also means the IRR on said targets will probably drop in the future.

Finally, the Rollins family has also been selling their stake in the company’s shares, having sold over $1.5 billion worth of stock. With founders and the family selling, it makes me question whether they view the stock as egregiously expensive now or if the landscape has gotten more competitive. For example, Rentokil (RTO), Rollins’ major competitor, has growing faster with arguable better capital allocation, acquiring best in-class companies like Terminix. Rentokil has gotten more aggressive in M&A and has now overtaken Rollins as the largest company in the space. Despite more debt on its balance sheet, Rentokil trades at a much more favorable valuation at 12.0x forward Ev/EBITDA and 20.1x forward P/E (source: S&P Capital IQ). So if I was going to buy a stock in the pest control space, it’d most likely be Rentokil due to its large valuation gap with Rollins.

Conclusion

In summary, I think Rollins is a high quality business that should benefit from long-term tailwinds. With industry growth of 7.5% over the next ten years, Rollins is going to be a beneficiary of climate change, government regulations, and the long-term global shifts from rural to urban areas. While the company has been a consistent performer, I think the valuation has likely gotten ahead of itself at 28.1x EV/EBITDA and 51.6x P/E which is why I rate shares as a ‘sell’. For investors who still like the long-term attributes of the pest control business, I’d take a look at Rentokil which appears to have a much more reasonable valuation.