Rentokil (LSE: RTO) has reported an upbeat story for the third quarter of the year. It shows that the pest control and support services company is making good progress in growing its top and bottom lines. However, does it represent a sound investment opportunity for the long term?
Rentokil’s revenue from ongoing operations increased by 16.6% in the third quarter. Of this figure, 3.1% was organic and 13.5% was from acquisitions. Its pest control division delivered an excellent performance and was able to grow organically by 5.9%. Similarly, Rentokil’s hygiene business demonstrated further improvement and grew organically by 3.2%.
As has been the case in recent periods, Rentokil’s performance in emerging and growth markets was particularly strong. Its sales rose by 20.4% in the former and by 26.3% in the latter. This helped to offset a somewhat challenging performance in parts of Europe, with France in particular proving to be a tough market.
During the quarter, Rentokil acquired 13 businesses which included 10 in pest control. All of the acquisitions were in emerging or growth markets and this provides Rentokil with a sound long term growth platform, since demand for support services is likely to increase rapidly in those markets.
Looking ahead, Rentokil is forecast to increase its bottom line by 25% in the current year and by a further 12% next year. Combined with a price-to-earnings (P/E) ratio of 22.5, this puts it on a price-to-earnings growth (PEG) ratio of 1.9. This represents a fair value for the company, given its long-term growth potential in emerging markets.
Furthermore, Rentokil has impressive income potential. It yields only 1.4% at the present time, but pays out less than a third of profit as a dividend. With such strong profit growth potential over the medium-to-long term, Rentokil’s dividends could rise at a rapid rate and could even be ahead of earnings growth in future years. Combined with its diverse business operations and geographical diversity, this makes Rentokil a sound purchase.
Upside potential
However, within the support services space there’s better value for money and higher yields available. For example, G4S (LSE: GFS) is forecast to grow its earnings by 4% this year and by 12% next year. When combined with a P/E ratio of 15.3, this puts it on a PEG ratio of 1.3. While Rentokil is fair value for money, G4S offers significantly greater upside potential over the medium term.
Similarly, G4S has a higher yield than Rentokil. It currently yields 4.1% and while dividends are not as well covered at 1.6 times versus 3.1 for Rentokil, G4S has sufficient headroom to make its dividend outlook relatively secure. Its strong profit growth outlook also means that dividends could grow at a brisk pace.
While both stocks are worth buying for the long term, G4S seems to be the superior buy due to its higher yield and lower valuation.