Rentokil Initial: valuation gap with US peers will be a tricky bug to squash

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How can UK-listed pest controller Rentokil Initial complain its business is slowing down in the middle of an infestation? The wrong kind of bugs are to blame — and with better justification than the wrong kind of leaves once blamed for train delays.

Europe is wracked by a plague of bed bugs, if you believe tabloid coverage. But Rentokil’s problem is a slowdown in US spending on problem critters, termites in particular. That reflects a deceleration in housing transactions.

Investors scratched the itch, sending Rentokil shares down as much as 20 per cent on the day. 

Rentokil bet big on North American growth last year with the £4.5bn acquisition of Terminix. Short term, this now looks like poor timing. Rentokil said organic growth in North American pest control was just 2.7 per cent year on year in the third quarter, almost half less than forecasts.

As its name suggests, Terminix’s main business line is termite control. The acquisition roughly doubled Rentokil’s North American sales, which are expected to be £3.3bn this year — 60 per cent of the group total — according to Visible Alpha. Rentokil says cost savings of £113mn will materialise fully by 2026.

Rentokil is now bigger in the US market than closest rival Rollins. Following Thursday’s decline, its shares trade at 18 times forward earnings, the lowest level since 2017. Even after a smaller decline in Rollins’s share price, the discount is now at half, the biggest since the end of last year.

A higher rating for Rollins is underpinned by better profit margins and higher returns on capital. That is a sore point for Rentokil, which has been one of the FTSE’s best performers. The group is also — for the moment — a top-tier member of Lex’s XFT index, comprising steady, low-profile compounders.

Rentokil’s medium-term credibility now depends on avoiding further upsets and driving higher margins out of the Terminix deal to bolster margins. This will be a multi-tasking test every bit as demanding as squashing roaches skittering across a counter when a light goes on.