While the FTSE 100 has made a positive start to 2025, shares in Rentokil Initial (LSE:RTO) are down almost 20%. In my view, that puts them in bargain territory – and I’ve been buying as a result.

At a price-to-earnings (P/E) ratio of around 27, the stock looks expensive. But I think things could look very different a couple of years from now, which is why I’ve decided to add to my investment.

First sight: expensive

A first look at Rentokil doesn’t stand out as a bargain. 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 much not the direction things are supposed to be going in. Especially not with the likes of Alphabet (25) and Meta (22) trading at meaningfully lower multiples while growing. 

Rentokil shares come with a bigger dividend – at today’s prices, the yield is just under 3% – but that by itself isn’t a reason to consider buying the stock. Investors should probably hope for better. 

I think, however, that there are strong reasons to believe that better things are on the horizon. And while the market focuses on the near term, I’m buying the stock for the long haul.

Margins

Rentokil’s revenues have actually been growing pretty impressively – sales have almost doubled since 2019. From an investment perspective, that’s something I can work with.

The trouble is, margins have collapsed. Five years ago, the company’s operating margin was around 14%, but this fell back to 10% in 2024 and is why earnings per share are down. 

That doesn’t sound like a lot, but margins declining at that rate means a 30% decline in profits. I think, however, the firm is on the road to recovery and this should show up in the next couple of years. 

Rentokil has been working its way through a period of higher costs after the acquisition of its US rival Terminix. But as the company integrates its new operations, I expect a recovery in profitability. 

My price target

If Rentokil can get its margins back to 15% (which I think is plausible), earnings per share should reach 21.25p. And a P/E multiple of 20 implies a share price of £4.25 – almost 33% above the current level.

Obviously, there are no guarantees. The Terminix integration is proving more difficult and more expensive than investors might have hoped and the risk is this continues and margins stay depressed.

Given the way things have gone so far, I wouldn’t rule this out. But both the dividend and the potential for revenue growth create a margin of safety in my projections that somewhat offset this risk.

My anticipated return doesn’t include either of these and a growing pest control market means this seems likely to me. So while there’s a lot of uncertainty, I think the share price more than reflects this.

Undervalued?

At a P/E multiple of 27, Rentokil shares don’t look like they’re undervalued. But I think expanding margins could make profits rise sharply over the next couple of years. 

I don’t believe this is being reflected in the share price at the moment. And I’ve been putting my money where my mouth is on this one and buying the stock for my portfolio.