Undervalued by 35%, This Wide-Moat Stock Is a Buy

In a market where high-quality growth stocks look overpriced, Rentokil Initial presents opportunity. We think the stock of this midsize wide-moat company looks awfully undervalued today. Rentokil is trying to turn around its North American pest-control business, and we think the market is taking an overly pessimistic view of management’s ability to right the ship. Rentokil lands on Morningstar’s latest 10 Best Companies to Invest in Now list. The stock is also one of 3 Top Stocks for Growth Investors to Buy Now.

Rentokil aims to consolidate the pest-control and hygiene-services markets, which remain substantially fragmented. To this end, it has completed over 200 acquisitions since 2015, focusing on targets that build the geographic density of its customers. The late 2022 acquisition of Terminix Global Holdings was a transformative and moat-reinforcing deal, creating a new US market share leader. Pest-control acquisitions remain Rentokil’s top priority, but tuck-in candidates for the hygiene segment are now also set to become a focus. The company’s successful execution of this strategy has delivered a durable cost advantage for the pest-control business—the source of our wide economic moat rating. While mergers and acquisitions attract risk, we remain in favor of Rentokil’s approach, noting that risk also exists in failing to participate in the ongoing global industry roll-up.

Key Morningstar Metrics for Rentokil

• Fair Value Estimate: $40.30
• Star Rating: 5 Stars
• Economic Moat Rating: Wide
• Uncertainty Rating: Medium

Economic Moat Rating

We assign Rentokil a wide moat rating owing to the superior cost position of its global industry-leading pest-control franchise. Rentokil is the world’s largest commercial pest-control business, boasting leading market share in the vast majority of the 90-plus countries in which it operates. This has been achieved in large part via vigorous tuck-in acquisition activity aimed at reaping the cost benefits that accrue to a route-based business like pest control as density of service provision increases. The acquisition of the Terminix pest-control franchise, which gave Rentokil a market-leading position in the US, has strengthened the cost-led economic moat surrounding its global pest-control franchise. Rentokil’s business model augments the scale advantages of its pest-control business.

Read more about Rentokil’s moat rating.

Fair Value Estimate for Rentokil Stock

Our fair value estimate is $40.30 per share. We forecast a 10-year EBIT compound annual growth rate of about 10% and expect a 10-year revenue CAGR of approximately 7%, consisting of approximately 5% in annual organic sales growth and a further 2% annually from tuck-in acquisitions. We expect Rentokil’s organic growth to be supported by global trends of increasing urbanization and expanding economic prosperity—particularly in emerging markets—driving increased per capita spending on pest-control and hygiene services. We expect EBIT margin to widen to about 23% at midcycle, from 16.7% in 2023, as the group reaps the benefits of increased scale and realizes cost synergies from the Terminix deal. We estimate Rentokil’s cost of capital at 8.4%.

Read more about Rentokil’s fair value estimate.

Risk and Uncertainty

Demand for pest control and hygiene services benefits from the essential role those services play. As a result, Rentokil’s pest-control service revenue is largely insensitive to the vagaries of the business cycle. The highly contracted nature of this revenue provides further through-the-cycle earnings protection. However, the proportion of fixed costs in the cost structure does leave the group’s operating margin exposed to customer losses, which mitigates some of the virtues of scale economies enjoyed by the business. The pest-control business implements a range of chemical-based pest interventions. Some of these chemicals—which include pesticides and rodenticides—can, if implemented incorrectly, be dangerous should they come into contact with customers, Rentokil personnel, or the surrounding environment.

Read more about Rentokil’s risk and uncertainty.

Rentokil Bulls Say

• Rentokil is well positioned to benefit from fast-growing pest-control markets in Asia.
• Broad adoption of Rentokil’s digital pest-control offering is likely to drive market share gains.
• Further scale economies are likely to accrue from ongoing M&A.

Rentokil Bears Say

• The spike in hygiene awareness observed during the coronavirus pandemic may not yield permanently higher growth for the health and wellness business.
• Competition is heating up for pest-control acquisitions—particularly in the US—putting upward pressure on deal multiples.
• The hygiene business’ cost-curve position is unlikely to materially improve in the near term, with pest-control M&A still the focus.

This article was compiled by Susan Dziubinski and Sylvia Hauser. Data as of Nov. 20, 2024.