In the past, I’ve recommended buying pest control business Rentokil Initial (LSE: RTO) due to its defensive business model, global operations, and opportunity to grow in the world’s burgeoning pest control and hygiene market.
However, since I last covered the business, the stock has risen by around 15%, excluding dividends and, after these gains, I think it could be time to take profits.
Too expensive In my opinion, Rentokil now appears costly relative to its projected growth. Its shares are currently dealing at a forward P/E of 25.6. Even though earnings per share are expected to increase by 83% this year, that still gives a premium PEG ratio of 2.6 — a ratio below one implies the shares offer growth at a reasonable price.
At this valuation, if the company misses City expectations, the shares could lurch lower, which would be a disappointing result for investors. However, it would also allow investors who have been sitting on the sidelines to buy in at an attractive valuation.
And that’s what I think holders should do today. While I believe shares in Rentokil are overvalued, I’m still optimistic about the outlook for the group as there will always be a demand for pest control services around the world, and Rentokil is one of the best in the business. However, I don’t think it’s worth paying such a premium for the shares. It will be better, in my opinion, to sell up and buy back in at a more attractive valuation.
A better buy If you want to sell Rentokil and buy into another FTSE 100 growth stock, I recommend Coca Cola HBC (LSE: CCH). This company immediately stands out to me as a better buy because the shares are cheaper.
The stock is trading at a forward P/E of 20.3, which may look expensive compared to the rest of the market, but it’s in line with the rest of the UK beverage industry average (shares in Rentokil are valued at double the sector average, by comparison). Also, this Coca-Cola (NYSE:KO) bottler supports a more attractive dividend yield of 2.2%, compared to Rentokil’s 1.3%.
Further, according to my research, Coca Cola HBC is more predictable as a business than its smaller FTSE 100 peer. The company’s operating profit margin has increased from 5.4% to 9.6% over the past six years, rising steadily every year. Meanwhile, Rentokil reported an operating profit margin of 10.7% in 2016 and then 30.7% in 2017 before it fell back to -3.9% in 2018.
Balance sheet strength Coca Cola HBC also has a much stronger balance sheet because the business doesn’t rely on acquisitions as much as Rentokil. Based on last year’s figures, the company’s net debt, as a percentage of shareholder equity, was less than 20%, compared to Rentokil’s 136%.
So this suggests Coca Cola HBC is more predictable as a business, has a stronger balance sheet and the shares are cheaper. In my opinion, all of these factors mean the company is a better investment than Rentokil, especially considering the latter’s premium to the rest of its sector and the broader market.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019