CIGI - Colliers International: Margins Could Come In Better Than Expected

2023-05-17 22:45:12 ET

Summary

• The decline in margins, particularly in Europe, was more severe than expected and led to a drop in the share price, in my opinion.
• Despite weak 1Q23 results, management's revised guidance suggests a positive revenue performance for the rest of FY23. If the macro environment stabilizes, growth could exceed expectations, in my opinion.
• The market seems to undervalue CIGI's growth plans, including increasing the mix of recurring EBITDA and implementing cost-cutting measures.

Overview

Colliers International Group ( CIGI ) operates globally in the real estate services sector providing a variety of services in commercial real estate, residential property management and property services for residential and commercial properties across 65 countries. I am recommending a buy rating for CIGI stock. My thesis for CIGI is more of a tactical long as I believe CIGI should be able to print better than expected margins for FY23/24. Expectations for the stock has certainly been revised lower given the sharp drop in share price post the earnings, where margins came in weaker than expected. Valuation has also rerated lower to 1 standard deviation below its 10-year historical average, which is a compelling entry point as the stock has only touched this level 3x since 2016.

What drove the drop in share price

I believe the key driver for drop in share price is the decline in margins, that was much more than expected. At the top line, Capital Markets revenue declined 41% in the Americas and 55% in EMEA, which were not exactly surprising. The margin contraction in Europe was unexpectedly severe, especially in comparison to the Americas, which have a lower fixed cost base. Additionally, 1Q23 typically has lower revenue as such, which, when coupled with a higher fixed cost base, results in higher decrement margins printed.

Margin could come in better than expected in the coming quarters

With the weak 1Q23 results, guidance is now revised downwards with total revenue expected to grow in the range of $4.4-$4.6 billion ($4.5 billion at the mid-point), vs $4.6-$4.8 billion ($4.7 billion at the midpoint) previously, which imply a 4% guide down and a 1% growth from FY22. Implicitly, this also means that management is expecting revenue performance for the rest of FY23 to be positive. I believe the revenue guide here might be a little too conservative as Capital Markets revenue is expected to be down 30-40% in 2Q and continue to slowdown in 3Q/4Q given the uncertainty in the macro environment, especially due to the banking turmoil. In my opinion, if the macro environment settles and stabilizes, growth could be a lot better than expected due to the favourable comp vs last year (especially in 4Q). If we assume that things turn for the better and CIGI reverts to a normalized level of Capital Markets revenue (assuming the segment grew at GDP-like levels since 2019), it should generate ~$800++ million in revenue, which implies a positive growth in 2H23. If this happens, we should see very positive sentiment driving the stock price upwards.

As for margins, adj EBITDA is expected to come in at $670-$720 million ($695 million at the midpoint) vs $710-$750 million ($730 million at the midpoint), implying 10% growth and margin at 15.4%. Doing the same exercise, we can see that management is expecting EBITDA growth to turn positive in the coming quarters, with implied EBITDA margins at 16.7% at the midpoint for 2Q to 4Q. However, consensus is expecting FY24 margins to only increase by 20bps vs FY23 levels. While I acknowledge that the 16.7% margin seems too elevated, especially when we compare to history, I do think the expectation is too low as the market seems to not price in CIGI growth plans of growing the mix of recurring EBITDA from 60% to 65% (which I believe carries higher margin). I note that management mentioned they are on track to meet this plan. In addition, management announced cost cuts for 2023 that should result in positive margin impact, which is expected to be ~$90 million or 2% at the midpoint of guidance. The areas of cost cuts include non-revenue producing headcount, discretionary spend, reduction of office space and other efficiency improvements.

Valuation

CIGI stock has derated from the height of 25x forward earnings to the current level of 12.4x. If we look at its valuation history (from 2015 to today), there are only 3x that it has touched this level (end of 2018, covid period, and end of 2022). In all 3 cases, valuation eventually revert back to the average of 15.8x within a year. From 12.4x, this represents a 27% upside, excluding any earnings growth.

Concerns

A key concern, also linked to the macro environment is that fundraising environment is still tough, although management expects activities to accelerate in 2H23. On one hand, I believe CIGI might has an edge here given its focus on the alternatives and infrastructure investors, whom capital needs to be deployed. On the other hand, a major recession would basically kill any positive momentum in fundraising, in my opinion.

Conclusion

I recommend a buy rating for CIGI given the compelling entry point as the valuation has rerated lower to a level. Although 1Q23 results were disappointing, management's revised guidance suggests a positive revenue performance for the rest of FY23, with the potential for better-than-expected growth if the macro environment stabilizes, in my opinion. Furthermore, CIGI's focus on cost-cutting measures and plans to increase the mix of recurring EBITDA should lead to improved margins in the coming quarters. While the market seems to undervalue these growth plans, the potential for higher margins and positive margin impact from cost cuts should drive positive sentiment and support an upward trend in the stock price.

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