THE HEDGEYE EDGE
Rollins (ROL) provides pest control services and protection against termite damage, rodents and insects to customers throughout the United States through subsidiaries like Orkin, PCO Services, and HomeTeam Pest Defense.
The current share price of Rollins makes little sense to us, and we expect a significant downward revaluation by the market.
Margin gains have stalled amid increasing competitive intensity in a mature, slow growing market. Attractive markets for growth and acquisitions present less runway and higher transaction prices.
INTERMEDIATE TERM (TREND)
We are not saying ROL is bad, corrupt, or anything like that. We just see it as facing an organic growth deceleration and some aggressive competition. Aggressive foreign entrants like Rentokil and Anticimex are determined to take market share. Simply put, this is a low-barriers to entry business with GDP-ish growth.
Competition is less of an issue when industry revenues are growing. We see cause for concern. Slowing from weather, housing, or a decelerating economy could bring greater competitive intensity. It won’t be perfect forever, and ROL is priced for perfection.
Acquisitions have filled in during periods of weaker organic growth. This is fine, as long as the acquisitions are reasonably priced and successfully integrated. However, smaller pest companies often have better relationships as acquisitions by larger players destroys culture and employee retention. We estimate that, across the pest control industry, the acquisition price relative to revenues has nearly doubled in the last five years.
Without M&A above historical trends or share repurchases, we don’t see how ROL avoids a return to GDPish profit growth. Neither of those look attractively valued.
LONG TERM (TAIL)
With GDP-type organic growth rates, housing headwinds, competitive entry, and a feuding family with a controlling stake, one would reasonably expect ROL to trade at a discount to the market. We expect a growth deceleration, consolidation of leases, a host of yellow/red flags, and broader coverage to generate >50% downside, as the S&P 500 addition premium fades from the share price.