Rollins: A Best-In-Class Roll-Up Company (NYSE:ROL)

Investment Thesis

Rollins (NYSE:ROL) has been a quality compounder in the past decade with shares up nearly 570%, significantly outpacing the S&P 500 Index (SPY) by over 350 percentage points. The company operates in an attractive market and its roll-up strategy has been seeing huge success thanks to best-in-class management. The latest earnings once again demonstrated great stability with double-digit growth in both the top and the bottom line. However, the company’s valuation remains a major concern as it continues to trade at a lofty multiple. Despite the outstanding fundamentals, the valuation will likely limit its near-term upside potential, therefore I rate Rollins as a hold.

Why Rollins?

Rollins is a US-based company that specializes in pest control, and termite & ancillary services. Pest control is a boring yet attractive industry. According to Markets and Markets, its market size is forecasted to grow from $22.7 billion in 2021 to $29.1 billion in 2026, representing a solid CAGR (compounded annual growth rate) of 5.1%.

Besides the size and growth, its resiliency is also extremely compelling. For instance, most pest control services are non-discretionary and over 80% of services are recurring. This makes companies like Rollins essentially immune to economic downturns. As shown in the chart below, the company’s revenue increased by over 5% YoY during both the Great Financial Crisis in 2008 and the recent COVID-19 Pandemic in 2020.

Other than riding the ongoing market expansion, Rollins has also been accelerating its growth by rolling up smaller companies. For instance, it acquired over 27 companies last year for roughly $110 million, and recently announced a larger acquisition of Fox Pest Control for $350 million.

The company continues to see great success with this strategy as the management team can always maximize the value of the acquiree. Every acquisition is highly synergetic and accretive, and the “smaller-sized” nature of these deals also prevents complexity. I believe there should still be ample acquisition opportunities as the industry remains extremely fragmented. According to the company, there are currently over 20,000 competitors in the US alone, which should allow further consolidation down the stretch.

Upbeat Q1 Earnings

Rollins announced its first-quarter earnings last week and the results are excellent, as growth remained strong despite facing a tough macro backdrop.

The company reported revenue of $658 million, up 11.4% YoY (year over year) compared to $590.7 million. Organic revenue growth was 9.2%, while acquisition contributed the remaining 2.4%. Termite and Ancillary was the strongest segment, with revenue up 14.1% from $119.7 million to $136.6 million, accounting for 20.8% of total revenue. Commercial revenue increased 12% from $205.8 million to $230.4 million, accounting for 35% of total revenue. Residential revenue increased 9.4% from $259.3 million to $283.6 million, accounting for 43% of total revenue.

The bottom line was even stronger as the company continues to improve on operating leverage. SG&A (sales, general and administrative) expenses grew 9.8% from $178.8 million to $196.4 million, well below the pace of increase in revenue. Operating expenses (including costs of sales) as a percentage of sales dipped 110 basis points from 84.1% to 83%. This resulted in the adjusted EBITDA up 18.4% YoY from $117.8 million to $139.5 million. The adjusted EBITDA margin expanded 130 basis points from 19.9% to 21.2%. Net income increased 19.5% YoY from $73.8 million to $88.2 million. The diluted EPS was $0.18 compared to $0.15.

The company ended the quarter with a very healthy balance sheet. Cash in hand was roughly $122.1 million while the total debt was $341.3 million. This translates to a debt/EBITDA ratio of less than 0.5x, which provides ample flexibility for more acquisitions in the future. Earlier this year, the company also raised its quarterly dividend payout from $0.10 to $0.30, representing a massive increase of 30%.

Lofty Valuation

Rollins’ valuation continues to be a major issue. The company is currently trading at a PE ratio of 54x, which is extremely expensive in my opinion. As shown in the first chart below the multiple is meaningfully higher than other notable roll-up companies such as TransDigm Group (TDG), Watsco (WSO), and Waste Connections (WCN). The group has an average PE ratio of 38.4x, which represent a discount of 28.9% compared to Rollins. Despite having great fundamentals, the valuation gap seems hard to justify as TransDigm and Waste Connections actually reported better growth rates, as shown in the second chart below. Unless Rollins can significantly accelerate its growth, I believe it should be highly unlikely to see further multiples expansion.

Investors Takeaway

Rollins is the definition of a great company trading at a bad price. The company’s resilient and expanding end market alongside its roll-up strategy should be able to drive consistent growth over the long run. The stability is shown in the latest earnings as growth remains strong despite facing a slowing economy. However, the current valuation is too elevated and will likely limit its upside potential. Therefore I believe the company is a hold at the moment and investors should be patient and wait for a more attractive entry point.