Rentokil Initial PLC (LON:RTO) has been upgraded to ‘Buy’ from ‘Hold’ by HSBC as the FTSE 100 company shifted its business mix more heavily toward its pest control arm.
Analysts at the London-based bank said: “Rentokil has altered its business mix at a much faster pace than we had anticipated to become a purer pest control player. The current valuation is reflecting the mix shift the company has achieved so far. We see upside in the scenario if the company continues such a transformation. We believe this is likely as it is consistent with management’s stated strategy.”
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They added: “The Pest business is growing at a relatively faster rate than Hygiene and P&E and is typically less capital intensive and offers high returns on capital employed…Textile rental and Hygiene on the other hand are highly capital intensive and offer lower returns”.
The bank also hiked its price target for the group to 440p from 290p, a 26% premium on its last close price of 348.5p on June 8.
The bank commented: “Investors seem to be willing to pay a premium as the earnings shift more towards the high margin and less capital-intensive Pest control business.
“The current valuation appears to value the stock on an 8-9% EPS [earnings per share] CAGR [compound annual growth rate] (2017-20e) with 67-70% pest control business. But if the company continues to transform as per its stated strategy, we are looking at a 17-18% EPS CAGR with 78-80% from the Pest control business” they added.
The upgrade follows a strong first quarter performance from Rentokil, in which it reported revenue increases of 10.8% year-on-year for the period, while year-on-year organic revenue growth in the first three months of 2018 accelerated to 3.2% from 3.1% in the final quarter of 2017.
In mid-morning trading, Rentokil shares were up 1.5% at 354p.