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This Rollins stock analysis explains why I have initiated a position in one of the 'Core' accounts within the FFJ Portfolio.
In ROL, we have a company with over 20 years of improved earnings. It had also increased its regular quarterly dividend for 18 consecutive years when it made its January 28, 2020 dividend announcement. The ROL at a glance statistics on its website is slightly outdated in that it only shows sales for FY2012 - FY2018. ROL's FY2019 and FY2020 revenue, however, is $2B and $2.16B.
The past does not predict the future. It is, however, hard to overlook ROL's ~20% average annual total return for the 10 year period starting mid-June 2011. This is impressive considering the dividend yield is typically under 1% and a 15% return was generated from an investment in the S&P500 over the same timeframe.
Rollins - Stock Analysis - Business Overview
Although ROL's history dates back to 1893, it may not be a recognizable name. Many readers, however, may be familiar with some of the underlying businesses.
ROL has grown organically and through multiple acquisitions over the years. Today, it is a leader in the highly fragmented global pest control industry. The company's growth is borne out from the fact that it generated annual revenue under $0.65B in FY2000. Fast forward to FY2021 and revenue is very likely to be over $2.16B.
The Balance Sheet of many companies that grow through acquisition often becomes laden with debt. Despite growth through acquisition, ROL has a low debt/equity level. In fact, it has so little debt that no rating agency rates its debt.
Furthermore, very few analysts (as in 3) follow ROL.
ROL is a 'Controlled Company' because a group that includes ROL's Chairman of the Board and CEO, Gary W. Rollins who is 76 years old (#539 on Forbes' list of billionaires with an estimated net worth above $5B), and certain companies under his control, controls over 50% of the voting power. As a 'Controlled Company', ROL need not comply with certain NYSE rules.
Furthermore, ROL's executive officers, directors and their affiliates hold directly, or through indirect beneficial ownership, in the aggregate, ~54% of the outstanding common shares. These persons effectively control ROL's operations, including the election of directors and approval of significant corporate transactions such as acquisitions and approval of matters requiring stockholder approval. This concentration of ownership could have the effect of delaying or preventing a third party from acquiring control at a premium.
Some investors may view this as a weakness. I view it as a decision made for what is best for the company. The degree of control insiders have over the company means decisions are not made to appease the investment community.
Information Sources
The following are links to my sources to aid in your own analysis.
Part 1 of the FY2020 10-K has a good overview of ROL's industry, customers, business strategy, solutions and risks. Additional information is also available in the following:
Rollins - Stock Analysis - Industry Overview
Pesticides are chemicals or mixtures of chemicals used to mitigate pest damage.
Pest control is the management of specific species of insects that are recognized as detrimental to human health. House flies, bed bugs, cockroaches, and other insects tend to reside in places where there are human activities. This can lead to serious health issues, and therefore, pest management has gained significant importance over time. In fact, the COVID-19 outbreak has had a positive impact on the global pest control market. This is partially due to the support from government bodies that offer subsidies to key industry participants in the pest control market.
Pest control market growth factors include the implementation of stringent government regulations in the developed regions (eg. North America and Europe). The purpose of these stringent government regulations is to protect the environment. Another contributing factor to the industry's growth is the constant change in climatic conditions; pests survive at elevated temperatures so global warming is fueling the growth of pests.
The Asia-Pacific pest control market size is projected to grow at the highest CAGR of 7.9% between 2020 and 2027. Pest control key players in China are following developmental strategies to enhance the sales of organic pest control products in this region. Rentokil Initial plc, for example, has entered into a strategic partnership with Beijing Taiming Technology Ltd., a leading pest control service provider in China that owns several fumigation patents in its name.
In 2019, the 'insects' segment was the largest revenue-generating segment and expectations are for ~5.0% CAGR between 2020 and 2027. The other segments are termites, rodents, and others.
The global pest control market forecast value in 2019 was $20.6B. Projections call for $30B by 2027. This is a ~5.2% CAGR from 2020 to 2027.
Competition
The principal methods of competition in the Company’s pest and termite control markets are quality of service, customer proximity, guarantee terms, reputation for safety, technical proficiency, and price.
ROL's major competitors include Terminix (TMX), Ecolab (ECL), Rentokil (RTO) and Anticimex (private).
ECL is another impressive company with a ~$60.8B market cap versus ROL's ~$16.3B market cap. ECL, however, does not compete exclusively in the pest control market.
TMX's market cap is ~$6.5B. I do not view this company as an attractive investment since Moody's and S&P Global rate this company's debt as non-investment grade speculative.
RTO's market cap is under $9B. S&P Global rates its debt lower medium grade (just 2 notches above non-investment grade speculative). The company is listed on the LSE and trades on the pink sheets in the US.
Anticimex is a private Swedish company.
Rollins - Stock Analysis - Financials
Q1 2021 Results
On April 28, 2021, ROL reported Q1 results in which total revenue, less significant acquisitions, grew 7.9% over Q1 2020 results. The residential and termite segments experienced 12.8% and 11.2% growth, respectively. On the Q1 call, management indicated these growth levels exceeded anything the company has recently experienced. In addition, the commercial segment, less significant acquisitions, presented positive growth for the first time since Q1 2020.
On the Q1 conference call, management indicated it does not see major inflation exposure that would materially impact margins. Payroll, fleet and materials and supplies are the 3 largest expense areas and payroll margins are mainly improving due to enhanced technology and efficiency. Fleet has been positively impacted by lower fuel costs and a mid-single-digit percentage reduction in miles driven. Materials and supply costs are lower as a percent of revenue even though there is the added cost of personal protective equipment used by customer-facing employees.
Q1 results were positively impacted by the ~$31 million gain on the sale of several of the Clark Pest Control properties; ROL purchased Clark's pest control, distribution businesses and their owned properties in 2019. Real estate is not ROL's core competency so a decision was made to sell the properties and to secure branch leases. The first group of properties sold netted a $31 million gain and this is included in the Q1 2021 numbers.
Q1 2021 revenue of $535.6 million increased 9.8% over Q1 2020 revenue of $487.9 million and GAAP income before income taxes was $119.9 million or 116.3% above Q1 2020.
Q1 2021 GAAP net income was $92.6 million, up 114.1% compared to Q1 2020 and GAAP EPS was $0.19. Deduct the ~$31 positive impact on the gain on the sale of the Clark properties and non-GAAP income before income taxes is $88.8 million versus $55.4 million in Q1 2020; this is a 60.3% increase. The non-GAAP net income was $69.8 million, up 61.2% compared to Q1 2020.
The company continues to attract customers to all of its services and brands. ROL's mosquito service revenue, for example, experienced growth of over 30% because of the continued threat of mosquito-borne disease and the fact families are spending more time outdoors recreationally.
Strong performance is evidenced in the U.K. and Australia. On the domestic front, Northwest Exterminating, which ROL acquired in 2017, continues to realize strong growth in the Southeastern U.S.. In addition, HomeTeam continues to experience consistent high-growth levels as it capitalizes on a thriving residential home construction industry.
ROL is also experiencing significant growth from its wildlife service offerings through its Trutech and Critter Control brands. ROL continues to selectively purchase Critter Control franchises and combine them with its growing wholly-owned wildlife operations.
The gross margin in Q1 increased to 51.2% from 49.5% in Q1 2020. This is partially the result of lower service salary expense and lower fleet expense through continuous improvements from ROL's routing and scheduling efficiencies.
BOSS System
In 2015, ROL began the rollout of its new branch operating system, BOSS, at its largest brand, Orkin U.S. ROL successfully deployed BOSS in two additional brands, Orkin Canada and Western Pest Services in FY2020.
In Q1, the new BOSS technology was tested as ROL experienced a surge in customer demand. Management is finding that this new technology is enabling technicians to continue to improve the efficiency of their day. The BOSS system now allows ROL to be proactive with customers instead of reactive. The operations support has added the use of a planning board, which enables them in real-time to adjust for openings in a technician's schedule. If a customer needs to reschedule service for some reason, that opens up a time slot during the day. The support group can now quickly fill that slot with a new customer or support the changing needs of an existing customer. In essence, technicians are now more efficient and ROL's customers have a better experience with their service needs.
As evidence of the improved efficiency because of this BOSS rollout, Orkin Canada has achieved routing improvements of over 20% even though its use of BOSS is in its early stages.
Importance of Unearned Revenue
In my recent Cisco – Dividend Achiever Review article, I explain how CSCO benefits from having ~$21B of total deferred revenue (its clients' money) sitting on its Balance Sheet.
At the end of Q1 2021, ROL has ~$140 million of unearned revenue on its Balance Sheet. While certainly not of the same magnitude as CSCO's total deferred revenue, we need to remember that ROL only generates a little over $2B in annual revenue versus ~$50B at CSCO.
FY2021 Guidance
Guidance is not provided.
Operating Cash Flow (OCF) Free Cash Flow (FCF)
Looking at the Condensed Consolidated Statement of Cash Flows in the historical 10-Ks we have FY2020 - FY2016 OCF of (in millions of $):
$436, $320, $299, $235, and $227
In FY2020 - FY2016, ROL's CAPEX (in millions of $) was $23, $27, $27, $25, and $33.
Back out CAPEX and we end up with FY2020 - FY2016 FCF of (in millions of $):
~$413, ~$293, ~$272, ~$210, and ~$144
In Q1 2021, ROL's OCF is ~$119 million. Back out ~$8 million in CAPEX and FCF is ~$111 million.
As noted earlier, ROL had a ~$31 million gain from the sale of assets and ~$65 million from the sale of assets.
ROL has clearly demonstrated it has a sound formula to generate OCF and FCF to finance its growth and to reward shareholders.
Rollins - Stock Analysis - Credit Ratings
ROL's debt is not rated.
Dividend and Dividend Yield
Looking at the 10-year total return from a ROL investment (see the beginning of this article), we see capital gains as the predominant portion of ROL's historical total return.
It is readily apparent ROL can reward investors to a far greater extent by retaining funds in the company to fund growth.
ROL's dividend history will not appeal to yield-hungry investors. It is important, however, to note that merely relying on stock screeners to determine ROL's dividend yield has its shortcomings. ROL is similar to CME Group (see April 6, 2021 post) in that it distributes a special dividend every year; stock screeners exclude this special dividend.
As noted earlier, ROL had increased its regular quarterly dividend for 18 consecutive years when it made its January 28, 2020 dividend announcement. On April 8, 2020, however, the regular quarterly dividend was cut from $0.12 to $0.08 as a precautionary measure. In announcing the dividend cut, ROL's Senior Vice President and CFO states:
'We believe that there is a need for caution as we execute our plans in response to the impact of COVID-19. This is a proactive move that is consistent with our Company's conservative balance sheet approach. We plan to return to our past dividend performance as soon as practical.'
ROL, however, distributes a 'special dividend' and the increase in the special dividend from the prior year results in the 10-K reflecting no net change in the total annual dividend distribution.
Page 21 of 91 in the FY2020 10-K states:
In FY2020, a total of $160.5 million was paid in cash dividends ($0.33/share) including a special dividend paid in December 2020 of $0.09/share
In FY2019, a total of $153.8 million was paid in cash dividends ($0.31/share) including a special dividend paid in December 2019 of $0.03/share.
ROL has had several stock splits over the years.
When a company initiates a stock split, the number of outstanding shares increases and the price per share decreases. However, the value of the company does not change. As a result, stock splits help make shares more affordable to smaller investors. It also provides greater marketability and liquidity in the market.
ROL adopted a share repurchase plan in 2012 to repurchase up to 11.25 million shares of the Company’s common stock.
ROL did not purchase shares on the open market during the years ended December 31, 2020, 2019 and 2018. The number of shares outstanding at 2020 - 2016 year-end amounts to 491,612, 491,146, 490,962, 490,482, and 490,031 (millions of shares).
There remain 11.4 million shares, adjusted for the December 10, 2020 three-for-two stock split, authorized to be repurchased under prior Board approval. ROL did repurchase $8.3 million, $10.0 million, and $9.5 million of common stock for the years ended December 31, 2020, 2019 and 2018, respectively, from employees for the payment of taxes on vesting restricted shares.
Rollins - Stock Analysis - Valuation
ROL's diluted EPS for the FY2020 - FY2016 timeframe is: $0.53, $0.41, $0.47, $0.37, and $0.34 and its diluted PE during the same timeframe is 78.14, 52.63, 55.26, 54.74, and 45.65.
The company's valuation is rich if we rely on EPS and diluted PE to determine valuation. ROL's acquisition strategy, however, results in sizable depreciation and amortization expenses on the Consolidated Statement of Income (~$24 million in Q1 2021, ~$88, ~$81, and ~$67 million in FY2020 - FY2018). These are expenses that reduce EPS but they do not negatively impact cash flow.
Rather than rely on EPS, I use Operating Cash Flow/Number of shares outstanding at year-end (page 17 of 91 in the FY2020 10-K) and get FY2020 - FY2016 OCF/share values of ~$0.89, ~$0.65, ~$0.61, ~$0.48, and ~$0.46.
If we use FY2020 EPS of $0.53 and a 78.14 PE, the share price is ~$41.41. Divide this share price by OCF/share and the FY2020 valuation drops to ~46.5. This is not a low valuation. ROL, however, is not the type of company where you can expect a low valuation.
Rollins - Stock Analysis - Final Thoughts
I know ROL is an expensive stock no matter what way I look at it. What I like about the company, however, is that it is a dominant player in a highly fragmented industry. Furthermore, expectations are for this industry to witness significant growth over the next several years.
ROL, although in an entirely different industry, reminds me of Alimentation Couche-Tard (ATD-b). Both operate in a fragmented industry where the barriers to entry are low. They, however, are much more efficient than most of their competitors. They have a proven track record of acquiring less efficient operators and integrating these acquisitions to make them much more efficient and profitable.
Some investors might be concerned about ROL's decision to reduce its regular quarterly dividend in 2020. I think a decision not to invest in ROL because of this is shortsighted. The dividend cut, even though it was not entirely necessary, demonstrates prudence.
Furthermore, dividend income is not the primary motivation when investing in ROL.
ROL is also CAPEX light and thus generates strong FCF. This strong FCF allows it to grow through acquisition without burdening the Balance Sheet with a ridiculous amount of debt.
I also like that it has the use of a significant amount of its clients' money on its books BEFORE it generates any services. Clients are indirectly aiding in the financing of ROL's growth.
Gary W. Rollins, ROL's Chairman of the Board and CEO, and certain companies under his control, control over 50% of the voting power. The benefit of this degree of control is that decisions are more likely to be made based on what is best for the company as opposed to trying to placate the investment community.
We also see that Mr. Rollins has a net worth above $5B. Whatever he is doing is obviously working extremely well. As the saying goes:
'If it ain't broke, don't fix it.'
I have just initiated a 500 share position in one of the 'Core' accounts within the FFJ Portfolio; I intend to increase this position when the opportunity presents itself. This way I can benefit from ROL's successful business model.
Stay safe. Stay focused.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long ROL, ECL, and CSCO.
Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.
