Bottom Line: Rentokil shows strains of expansion

IT'S OFFICIAL: the widely admired profit margins earned by Rentokil, the hygiene and office services concern, are under pressure.

Some margin erosion was expected as Rentokil absorbed the inherently less lucrative Securiguard security business. The new worry is the Australian end of Rentokil's established operation and slower-than-expected growth in Europe.

Turnover grew by 40 per cent to pounds 357m for the six months to 30 June - largely thanks to the pounds 75m purchase of Securiguard this time last year. But pre-tax profits grew 20 per cent to pounds 80.6m as operating profit margins across the group slipped from 25.6 per cent to 22.3 per cent.

In response, Rentokil shares, which have been moving sideways in relative terms for a couple of years, fell 5 per cent to 222p.

Underlying growth of 13 per cent would be more than respectable for most companies, but not Rentokil, where 20 per cent is the norm.

Management difficulties were blamed for the Australian disappointment. But the problem has been how to exploit most effectively the growth opportunities.

And despite being shackled by Australia, Rentokil's Asia Pacific business as a whole still managed the requisite 20 per cent profits advance. Had Australia behaved, Asia Pacific would have won a 30 per cent increase.

Analysts scaled back full-year profit estimates from about pounds 180m to pounds 175m. That is equivalent to earnings of 11.8p and puts the shares on a forward p/e ratio of 19 times, a heady rating in combination with a 1.9 per cent gross yield after a 20 per cent dividend rise.

Rentokil shares peaked along with the rest of the stock market in early February. The stock has fallen by one-fifth since touching 279p, and in the same period has underperformed its peers by 10 per cent as highly-rated stocks were hit.

Despite this retreat Rentokil is still one of the best-rated stocks in its sector and trades at a 30 per cent premium to the market as a whole.

Cynics have not yet tripped up Rentokil but the strains of expansion are showing and the days of relentless outperformance may have gone.