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On June 10, 2021, I initiated a 500 Rollins (ROL) shares position @ ~$33.15/share and explained my rationale for doing so in this Rollins stock analysis. With the release of Q2 and YTD2021 results I now provide an update.
Rollins - Stock Analysis - Business Overview
Please refer to my June 10, 2021 post in which I present business and industry overviews.
New Executive Leadership Appointment
Recently, Becton Dickinson has announced its EVP/CFO/CAO's decision to retire as he reaches retirement eligibility. This will be an orderly transition.
In the case of Lockheed Martin, the recent announcement of its CFO's decision to retire for personal reasons and accompanying negative news has come as a total surprise to the investment community.
Now, ROL has announced a change at its CFO level; the new CFO was formerly ROL's Vice President - Finance and Investor Relations. She replaces ROL's former CFO who has transitioned to an operational role as Senior Vice President focused on sustainability. This transition is attributed to the ongoing Securities and Exchange Commission (SEC) investigation, which ROL believes is primarily focused on how it established accruals and reserves at period-ends and the impact of those accruals and reserves on reported earnings per share.
SEC Investigation
In ROL's FY2020 10-K, the company disclosed SEC’s investigation as it relates to period-ends for periods beginning January 1, 2015.
Within the 10-K commencing on page 27 of 91, is Grant Thornton LLP (the company's auditor) Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting. In this report, Grant Thornton states:
'We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2020, and our report dated February 26, 2021, expressed an unqualified opinion on those financial statements.'
A similar statement from Grant Thornton is included in 10-Ks for the prior years.
ROL continues to fully cooperate with the SEC’s investigation as it relates to period-ends for periods beginning January 1, 2015. This includes providing supplemental information and current and former employees for interviews and testimony.
The company’s Audit Committee retained independent counsel to conduct an initial internal investigation into matters related to the SEC investigation and, in particular, the processes for establishing reserves for each quarter in the relevant periods. This internal investigation, which was originally concluded in October 2020, is now being supplemented as a result of new developments in connection with the investigation. Details of the new developments are found on page 2 of 10 in the July 28, 2021 Form 8-K.
Acquisitions
ROL's growth over time has been organic and also through multiple acquisitions. On the Q2 2021 Earnings call, management indicated it has closed 18 deals YTD through the end of Q2 2021.
This is a highly fragmented industry and contemplated tax changes in the US appear to be spurring many small business owners to expedite their exit strategy before tax on capital gains potentially double.
Rollins - Stock Analysis - Financials
Q2 2021 Results
I reference ROL's Q2 and YTD results found in the Q2 2021 Form 8-K and Q2 2021 10-Q released July 28, 2021.
ROL continues to generate strong Operating Cash Flow (OCF) and Free Cash Flow (FCF). This has enabled it to repay $67 million under its revolving commitment, $48 million of its term loan, and to distribute $79.7 million in dividends over the first half of FY2021.
FY2021 Guidance
Management does not provide guidance.
Adjusted diluted EPS estimates from the very few brokers that cover ROL are reflected in the Valuation segment of this post.
Rollins - Stock Analysis - Credit Ratings
ROL's debt is not rated by any rating agency.
Details of ROL's debt facilities are provided in Note 11 on page 13 of 33 in the Q2 Form 10-Q.
ROL complies with applicable debt covenants and expects to maintain compliance throughout 2021.
Dividend and Dividend Yield
Investors who fixate on dividend and dividend yield will likely pass on ROL as a potential investment since the dividend yield is generally below 1%. Furthermore, many investors will likely also pass on ROL since it cut its quarterly dividend in April 2020.
In announcing the $0.12 to $0.08 dividend cut as a precautionary measure, ROL's Senior Vice President and CFO stated:
'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.'
Unless investors delve further into ROL's dividend history, however, they will not see that ROL distributes a 'special dividend'. When we look at the total amount distributed in recent years, we see that ROL increased the amount distributed in 2020 relative to 2019 for shareholders who held shares for the entire calendar year!
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.
Having said this, the bulk of ROL's historical investment return has been predominantly in the form of capital appreciation. I expect no change in this regard going forward.
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. Typically, shares repurchases are from employees for the payment of taxes on vesting restricted shares.
ROL did not purchase shares on the open market during the years ended December 31, 2020, 2019 and 2018. The number of shares outstanding for the past ~7 years has been relatively stagnant at ~491 - ~492 million shares.
There were no share repurchases in 2021 as per the Consolidated Statement of Cash Flows for the 6 Months Ending June 30, 2020 and 2021 (page 6 of 33) in the Q2 10-Q.
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.
Using the current ~$38.30 share price and current adjusted diluted EPS guidance, we arrive at the following:
- FY2021 - 3 brokers - mean of $0.69 and low/high of $0.69 - $0.70. Using the current share price and the mean, the forward adjusted diluted PE is ~55.5.
- FY2022 - 3 brokers - mean of $0.74 and low/high of $0.72 - $0.76. Using the current share price and the mean, the forward adjusted diluted PE is ~51.8.
- FY2023 - 1 broker - mean of $0.83 and low/high of $0.83 - $0.83. Using the current share price and the mean, the forward adjusted diluted PE is ~46.1.
The company's valuation is rich if we rely on EPS and adjusted diluted PE to determine valuation.
I do not value ROL based on EPS because ROL's acquisition strategy results in sizable depreciation and amortization expenses on the Consolidated Statement of Cash Flows (~$47 million YTD and ~$88, ~$81, and ~$67 million in FY2020 - FY2018). These sizable non-cash expenses reduce EPS but do not impact cash flow.
Rather than rely on EPS, I look at ROL's valuation based on OCF/share.
ROL has generated ~$219.2 million in OCF in the first 6 months of FY2021 and ROL's business is somewhat stable when we exclude major events such as the onset of a COVID pandemic. On this basis, I expect results in the second half of FY2021 to be somewhat similar to the first half thus my reason for projecting FY2021 OCF of ~$0.4B - ~$0.44B. The weighted average number of shares outstanding is ~492 million and I expect this to remain relatively stable over the remainder of the current fiscal year. If I divide the midpoint of the projected OCF by the weighted average number of shares outstanding, we get an OCF/share of ~$0.85. Using the current ~$38.30 share price and ~$0.85, we get a valuation of ~45. This is similar to the ~46.5 value at the time of my June 10, 2021 post.
ROL's valuation is not attractive but I like the company's long-term prospects. Since ROL's shares very rarely are on sale, I initiated a position on June 10, 2021.
Rollins - Stock Analysis - Final Thoughts
Although ROL cannot predict the outcome of the SEC investigation, I am relying on management's judgement that the impact will be immaterial should the outcome be unfavourable.
As far as the 2020 dividend cut goes, I think many investors blow this out of proportion. I view the precautionary dividend cut in 2020 as a 'non-issue'.
Essentially, my rationale for investing in ROL has not changed. I approach my ROL investment from the perspective that Gary W. Rollins, Chairman and CEO, clearly knows how to run a successful business. Were this not the case, Forbes would not estimate his net worth to be ~$5.6B as of August 6, 2021.
By investing in ROL I hope to capitalize on Mr. Rollins proven ability to create wealth from the highly fragmented but strong growth potential pest control industry.
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.
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.
