How Rollins Benefits From a Fragmented Pest Control Market

Orkin parent company Rollins (ROL 0.45%) has delivered strong growth over the years through a roll-up strategy, buying smaller companies and folding them in. In this episode of "Beat and Raise" recorded on Jan. 27, Fool contributors John Bromels and Brian Withers discuss how that strategy has paid off for Rollins and whether the combination of the No. 2 and No. 3 pest control companies poses a threat to it.

Brian Withers: John Bromels is going to kick us off today with Rollins. John, for those not familiar with the company, what the heck do these guys do?

John Bromels: Well, you might ask Brian, because they have done different things over the course of the company's history. Started out, believe it or not, doing mostly broadcasting and billboards. Yeah, I know like radio, TV broadcasting and billboards, that kind of multichannel. Then they bought a little tiny pest control company back in the '60s I think maybe, called Orkin. Gradually, Orkin has become their primary business. They've sold off most of their media stuff. Now it is primarily a pest control company and that is what Rollins does. Now, I go way back with this company because when I was a child growing up in Wilmington, Delaware where Rollins is headquartered or was headquartered at the time, I was in a children's theater version of Heidi with both Monique and Michelle Rollins, children of co-founder John Rollins. Yes, I knew them as Rollins Cablevision. [laughs] But pest control is the name of the game now. That is why I have my friend here providing background. The company reported earnings yesterday before the opening bell. Earnings they were OK. I don't know if you want me to get into this?

Brian Withers: Yeah. Share your screen.

John Bromels: Will do. Give me one moment.

Brian Withers: Yeah. While you're pulling that up, just for a reminder for members. Every stock we cover on Beat and Raise is a recommendation somewhere in the Backstage Universe. I think there's 26 different services that feed in and you could access to at least certainly the recs and the insight as we go through here. It may not be in a service that you subscribe to, but it's actually recommended in three full services as I see here.

John Bromels: Here is Rollins. Can you see that?

Brian Withers: Yeah, it looks great.

John Bromels: Great. The company does not offer guidance and has not for several quarters now. We don't have any company guidance to compare it to. But Q4 revenue. This is for the October through December 2021 period, $600.3 million, up about 12 percent over the prior year. That was the beat. The analysts were expecting something in the neighborhood of like $560-ish million, so a decent beat there. EPS on the other hand, $0.13 per share, that was a miss. It was flat. Year over year, analysts were expecting more like in the $0.15 and $0.16-cent range. The analysts believe that in Q1 of 2022, the quarter we're currently in, should have about $572.65 million, which would be up about seven percent over the last quarter. I will say the bulk of Rollins' revenue tends to come in in the second half of the calendar year. It shouldn't be concerning that people are expecting lower revenue in Q1 than in Q4.

Brian Withers: Yeah. It's possible John too that estimate was prior to the beat in this quarter. They typically update their estimates, especially after a beat. They may up their estimates in the coming month.

John Bromels: They may indeed. I wouldn't expect them to up it much past the $570 (milliion) range because like I said, generally speaking on a quarterly basis, it's Q3 and Q4 is where the ball is, usually have more revenue than actually Q1 and Q2.

Brian Withers: I guess that's when the bugs come out?

John Bromels: That is when the bugs come out. [laughs] What did I just do. There we are. Sorry about that. Highlights from the quarter. The termite business, this was a longtime thorn in Rollins' side. Rollins generally grows by acquisition. Pest control market, very fragmented. Rollins buys smaller companies and incorporates them into the Orkin brand. Well, if some of those companies that get on-boarded don't live up to the Orkin standard, particularly in terms of termites and a homeowner who has hired that company, they are working to control termites in their home and then subsequently uncovers a lot of termite damage, they can put in a claim against Rollins.

This was happening quite a lot, although over the last couple of years has really gone down. That has continued in this quarter, termite business up 14.3 percent year over year, and the amount of claims down and I mean down from their peak significantly. I think they said something like 300-some claims, this is across their entire operation. Much lower than it has been in the past. We're talking like ten times lower than its all-time peak which is very good for Rollins. There is a very technical SEC investigation going on regarding how they accounted for certain types of accruals in their financial statements. It would be super esoteric. I'm not going to bother to explain it. Just know that they had in Q3, set aside $3 million for a potential settlement there. They've added $5 million to that. They now have totaled eight-million-dollar accrual set aside for this potential settlement. But of course, keep in mind there quarterly revenue is in the high five low $600 million.

This is not really going to be, even if it's a pretty large thing. It's not probably going to impact shareholders at all or if it does, it will be relatively minor. Fuel expenses up again, of course, most of the pest control folks drive to the location. They're generally driving a van or a truck or something which can hold equipment that takes gas. Gas costs money, fuel expenses up 56.5 percent year-over-year. That has been a common theme over the last couple of quarters, is that fuel expenses are going up. However, the impact of labor shortages and the increased potential costs that they might see to attract labor have been comparatively minor according to management. They did not give specific figures, but they have said that they have not been as impacted by shortages as they had thought. They have not had to increase their labor costs as much as they might have thought. Those are relatively minor compared to the fuel expense in particular.

One concern that was raised on the call, Rentokil the number three pest control company is buying Terminix, the number two pest control company. Rentokil is much larger in the UK. They are the number three in the US. They are buying Terminix, which is number two in the US. That combined company is going to be much bigger than Rollins, which is the current number one company in the US in terms of size. However, Rollins says they're not concerned about it because it is a large fragmented market. One of management's comments was a merger of that size may actually cause quite a bit of problems in terms of incorporating various markets and that's when another company experiences problems. That actually could be an opportunity for Rollins to pick off some of that business.

You can see over here on the right side. It hasn't been that great of a year for Rollins, especially not the last six months, however, especially compared to the S&P, that's the orange line, S&P, purple line Rollins. However, I wanted to put that in context although I'm showing you also the five-year return. Five-year return looks much better of course, although still now roughly tracking along with the S&P, Rollins big dividend payer. So I use total return metric for both of these charts. And that's pretty much Rollins. Here's the thing, it's the classic Peter Lynch business. They do something boring. It's a little bit discussing. They pay a big dividend , they're in a fragmented market, so they buy up smaller competitors, and they pretty much do a good job of executing and operating every quarter. I hate to say not much to see here, but not a whole lot to see.

Brian Withers: It's interesting, I was looking up who the CEO is, and Gary Rollins is still the CEO and has been with the company for over 53 years. I guess the guy is now around 77.

John Bromels: He is one of the children of one of the original founders, founded originally by two brothers, John Rollins and, I'm going to forget the other one's name.

Brian Withers: Brother Rollins. [laughs]

John Bromels: John was the one I met because he came to the show of Heidi that I was in, with Monique and Michelle.