Whereas the FTSE 100 has made a optimistic begin to 2025, shares in Rentokil Preliminary (LSE:RTO) are down virtually 20%. In my opinion, that places them in cut price territory – and I’ve been shopping for in consequence.

At a price-to-earnings (P/E) ratio of round 27, the inventory seems to be costly. However I feel issues might look very totally different a few years from now, which is why I’ve determined so as to add to my funding.

First sight: costly

A primary have a look at Rentokil doesn’t stand out as a cut price. It trades at a P/E ratio of 27 and – alarmingly – its earnings per share have declined from 15.3p in 2019 to 12.1p in 2024. 

That’s very a lot not the path issues are presupposed to be getting in. Particularly not with the likes of Alphabet (25) and Meta (22) buying and selling at meaningfully decrease multiples whereas rising. 

Rentokil shares include a much bigger dividend – at right now’s costs, the yield is just below 3% – however that by itself isn’t a purpose to think about shopping for the inventory. Traders ought to in all probability hope for higher. 

I feel, nonetheless, that there are robust causes to imagine that higher issues are on the horizon. And whereas the market focuses on the close to time period, I’m shopping for the inventory for the lengthy haul.

Margins

Rentokil’s revenues have truly been rising fairly impressively – gross sales have virtually doubled since 2019. From an funding perspective, that’s one thing I can work with.

The difficulty is, margins have collapsed. 5 years in the past, the corporate’s working margin was round 14%, however this fell again to 10% in 2024 and is why earnings per share are down. 

That doesn’t sound like rather a lot, however margins declining at that price means a 30% decline in income. I feel, nonetheless, the agency is on the street to restoration and this could present up within the subsequent couple of years. 

Rentokil has been working its approach via a interval of upper prices after the acquisition of its US rival Terminix. However as the corporate integrates its new operations, I anticipate a restoration in profitability. 

My price goal

If Rentokil can get its margins again to fifteen% (which I feel is believable), earnings per share ought to attain 21.25p. And a P/E a number of of 20 implies a share price of £4.25 – virtually 33% above the present stage.

Clearly, there aren’t any ensures. The Terminix integration is proving harder and dearer than traders might need hoped and the chance is that this continues and margins keep depressed.

Given the way in which issues have gone to date, I wouldn’t rule this out. However each the dividend and the potential for income progress create a margin of security in my projections that considerably offset this danger.

My anticipated return doesn’t embrace both of those and a rising pest management market means this appears prone to me. So whereas there’s a number of uncertainty, I feel the share price greater than displays this.

Undervalued?

At a P/E a number of of 27, Rentokil shares don’t appear like they’re undervalued. However I feel increasing margins might make income rise sharply over the following couple of years. 

I don’t imagine that is being mirrored within the share price for the time being. And I’ve been placing my cash the place my mouth is on this one and shopping for the inventory for my portfolio.