Rentokil profit warning

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Not a red letter day. Support services conglomerate Rentokil Initial took a battering on Thursday. The warning that prompted the share price rout was relatively mild at first sight. Lower than expected volumes in one unit, its City Link mail service, will mean a downgrade to full-year profits of about 5 per cent. Yet the shares plummeted by more than a fifth, enough to see Rentokil drop out of the FTSE 100 at the next rebalancing.

Partly it is shock. Only a month ago management reaffirmed the outlook for this year and next with the third-quarter trading statement. The business-to-consumer side of City Link had already started to shrink, but this contributes just under a third of sales and conditions there reflect the softening of consumer appetites. Business-to-business turnover was still expanding, so the sharp slowdown – recent volumes are flat on last year – came as a surprise.

The warning also raises significant concerns for next year. Moving parcels around is a business that has high fixed costs. With pressure on margins from fuel and wage inflation, sales growth is essential to keep earnings moving. Stagnation could make profits in this division – which was expected to produce about a quarter of group operating profit in next year – rapidly disappear. Added to that is the danger of a slip-up in integrating Target Express, a mail courier bought in November 2006. The process of meshing the network of depots is due to begin in the new year and customers are unlikely to forgive any disruption to their supply chains.

At the present valuation, a 7 per cent dividend yield should provide support, and the break-up argument will naturally resurface – there is no compelling reason that textile hire, washroom services and mail should be under the same roof. But any big decisions are unlikely before Target is integrated. Deliverance looks a long way off.

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