Rollins (ROL): The Dividend Cut Was Disappointing

Rollins Inc (ROL) is one of those companies that most people probably do not know by name. However, it is a company that has well-known brands. Rollins owns Orkin, which is a pest control company. I think that many people in the U.S. know of Orkin since it is the market leader. Rollins is also a company that is well-liked by the dividend growth investor community. The company had paid a growing dividend for 17 consecutive years. This made the company a Dividend Contender. Most dividend growth investors assumed that the company would eventually become a Dividend Aristocrat and a Dividend Champion. The attraction was that pest control was thought to be recession resistant. That may be normally the case since the dividend survived the Great Recession. However, Rollins is seemingly being challenged by COVID-19. Rollins announced a disappointing dividend cut when it released Q1 2020 earnings results.

Overview of Rollins

Rollins provides pest (insect and rodent) and termite control services to over 2.4 million residential and commercial customers. The company traces its history back to 1901 and has operated as a public company since 1968. The company owns and operates Orkin as well as other brands around the world. The most well-known brand in the U.S., is Orkin. The company provides its services directly in North America and Australia and operates a franchise system in the rest of the world. In North America Rollins has ~20% market share in pest control services. Note that the company is controlled by the Rollins family who own over 50% of the shares. The Chairman, Vice-Chairman and CEO are all members of the Rollins family.

Rollins’ Business is Being Impacted By COVID-19

Rollins’ business is being impacted by COVID-19. The company is involved pest control. Many of its commercial customers are likely restaurants, food service locations, hotels, and similar businesses. It is well known that these customers are trying to maintain liquidity by minimizing expenses and retaining cash on the balance sheet. My guess is that pest control was an expense that was viewed as something that can be postponed. If a business has no revenue and is having difficulty paying the rent, then arguably paying for pest control is fairly low on the priority list. This is largely borne out by statements made by the company in the Q1 2020 Form 10-Q.

“Customer retention during the pandemic is less predictable, and of greater immediate concern. Our residential pest control business has remained consistent with seasonal trends, especially as temperatures rise across the U.S. and pest activity increases. Through the date of this filing, our commercial pest control business has been more adversely impacted, as it crosses multiple industries such as healthcare, food processing, logistics, grocery, retail and hospitality. Each of these industries is being impacted differently by the pandemic. Many of our commercial customers continue to operate as “essential” businesses; however, there are others that have temporarily closed and have suspended our commercial pest control services.”

The length and duration of COVID-19’s impact on Rollins is largely unknown at this time. However, there is no doubt that 2020 will be a difficult year for Rollins. It is also likely that 2021 will be a challenging year.

Rollins Disappointing Dividend Cut

Before Rollins disappointing dividend cut, the company paid a regular quarterly cash dividend of $0.12 per share giving an annual dividend of $0.48. The yield was barely over 1% at that amount. Rollins did not really have terrible dividend safety metrics. In 2019, Rollins had diluted earnings per share of $0.62 and the annual regular dividend was $0.42 per share. This gives a payout ratio of roughly 68%. This is a not a bad value, but it is greater than my desired target of 65% or below. But going back for the trailing 10-years, 68% was the highest payout ratio. The payout ratio was typically 55% or below.

Similarly, the dividend was well covered by free cash flow. In 2019, operating cash flow was $309 million. Capital expenditures were $27 million. This gives free cash flow of $282 million. The dividend required $137 million in cash giving a dividend-to-FCF ratio of approximately 49%. This is a good value and below my criterion of 70%. Further, Rollins had about $92 million of cash on the balance sheet, which would more than cover the quarterly dividend of about $35 million.

Hence, it was somewhat disappointing that Rollins cut the dividend. The company made very limited statements regarding the actual dividend cut. In the first quarter Form 10-Q, Rollins stated:

On April 28, 2020, the Company announced that the Board of Directors declared a regular quarterly cash dividend on its common stock of $0.08 per share payable June 10, 2020 to stockholders of record at the close of business May 11, 2020, to be funded with existing cash balances and available credit facilities. The Company expects to continue to pay cash dividends to common stockholders, subject to the earnings and financial condition of the Company and other relevant factors.

In a press release, the CFO stated:

We believe that there is a need for caution as we execute our plans in response to the impact of COVID-19.  This is a proactive move that is consistent with our Company’s conservative balance sheet approach.  We plan to return to our past dividend performance as soon as practical.

Rollins Attraction as a Dividend Growth Stock

Rollins has been an attractive dividend growth stock in the past. In addition, the trailing 10-year and 20-year returns are phenomenal. Take a look at the charts below. The 10-year average annual total return with dividends reinvested is approximately 22.9%. This crushes the roughly 13.2% of the S&P 500.  The difference is even more stark over the trailing 20-years. Rollins’ 20-year average annual total return with dividends reinvested is about 21.9%. Compare that to the approximately 5.7% trailing return of the S&P 500 over the same time period. 

Ten thousand dollars invested 10-years ago would be $78,553 today. The same amount invested 20-years ago would be $521,454 today. Clearly, almost any dividend growth investor would have loved to have owned this stock over that time period. But recently the main problem from the perspective of dividend growth investors is Rollins’ valuation.

The past success of the company and limited float has resulted in the stock trading at an elevated earnings multiple of 30X for an extended time period. In fact, the stock currently trades on a forward price-to-earnings ratio of over 60X at the moment. This is very overvalued from the perspective of dividend growth investing. There is more risk on the downside than on the upside for the stock price at this valuation.

Is the New Dividend Safe Now?

The question in some small investors minds now is likely “Is the Dividend Safe Now?” The dividend safety metrics are now better than before the cut. Consensus 2020 earnings is $0.65 per share. The forward dividend is now $0.24 per share. This gives a forward payout ratio of 37%. This is a solid value and puts the dividend on more solid footing, especially if Q2 2020 and Q3 2020 earnings come in lower than expected.

Similarly, from a free cash flow perspective, the dividend is safer. If we assume a 20% reduction in free cash flow this gives $226 million. The new dividend requires approximately $79 million (328 million shares x $0.24) in cash. So, this would be a dividend-to-FCF ratio of roughly 35%. This is also a solid value.

Final Thoughts on Rollins

Rollins dividend cut was disappointing. But Rollins is a company I would love to own at the right price. I think that Rollins will navigate through COVID-19, but 2020 and possibly 2021 will be challenging for the company. With that said, businesses will need pest control over the long-term. They will likely start pest services again as the economy returns to more ‘normal’ activity. This will take a while though. However, unless the dividend cut is made up before end of the year, Rollins will no longer be a Dividend Contender. The company has suggested that they will return to increasing the dividend. Of course, the timing Is not really known nor is it completely in the company’s control at this juncture.

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