HSBC equity analysts have downgraded Rentokil Initial to ‘hold’ from ‘buy’ on concerns about the integration of US-based Terminix and how Rentokil will improve ROCE.
Rentokil Initial’s capital base is now three times larger than before the Terminix acquisition and HSBC analysts have doubts about how the company can improve its return on capital, given Terminix had a lower ROCE than the wider Rentokil Initial group.
HSBC also noted the constraints of possible slower US growth later in the year and the operational challenges of integrating Terminix, including competitors using the disruption caused by the acquisition to steal business away from Terminix.
As a result, HSBC has cut its Rentokil Initial price target to 480p from 495p.
“We cut our adj EPS estimates by 1.4% for 2024e and by 2.2% for 2025e considering slightly lower operating margins and higher expected net finance costs. However, we increase our ROCE projections slightly, expecting better ‘capital turnover’. The business may do better, but we think our revised assumptions are safer and more prudent,” HSBC analysts wrote in a note.
“To set our target price, we still apply our target PE of 20x but on our revised estimate for 2024e. Our target PE is about 10 ‘turns’ lower than RTO’s peak PE multiple in 2022e, reflecting higher interest rates, discount rates, and uncertainty but allowing for the lack of cyclicality in the business model and the potential for higher future returns. Thus, we derive our now lower target price of 480p (from 495p).”
