CWK - Cushman & Wakefield: Watch Capital Allocation And Financial Outlook

2023-09-14 10:24:56 ET

Summary

• Cushman & Wakefield has the potential to engage in significant value-accretive capital allocation initiatives, assuming that it can meet its 30% free cash flow conversion target.
• But CWK's PM/FM business doesn't seem to be as defensive and resilient as what one would have expected, considering its recent performance and management commentary.
• I maintain my Hold rating for Cushman & Wakefield stock, as there are both positives and negatives associated with the stock.

Elevator Pitch

I leave my existing Hold investment rating for Cushman & Wakefield plc ( CWK ) stock unchanged.

My prior update for Cushman & Wakefield written on July 4, 2023 touched on the absence of visible catalysts for the stock. I focus specifically on CWK's capital allocation and financial outlook in the current article.

On the positive side of things, CWK has the ability to create meaningful shareholder value with capital allocation moves like debt reduction and share buybacks, if it meet its free cash flow conversion goal. On the negative side of things, I am concerned that the actual performance of Cushman & Wakefield's PM/FM (Project Management and Facilities Management) in the quarters ahead could disappoint the market. I think that a Hold rating for CWK is fair.

Capital Allocation

Cushman & Wakefield indicated at its most recent Q2 2023 earnings briefing that the company's target is to deliver a "free cash flow conversion" ratio of "around 30%." CWK also specifically mentioned at the second quarter results call that "days outstanding" and "a couple of other levers that we have at our disposal" will help to boost the company's future free cash flow.

Free cash flow as a proportion of normalized EBITDA for Cushman & Wakefield improved significantly from 10% for the FY 2019-2020 period to 30% in the FY 2021-2022 time frame, as disclosed in the company's August 2023 investor presentation .

CWK's average sales days outstanding were below 60 days for the Q2 2021-Q4 2021 period as per S&P Capital IQ data. But average sales days outstanding rose to the 60-70 days range between the first quarter of 2022 and second quarter of 2023. As such, there are opportunities for Cushman & Wakefield to improve the company's free cash flow conversion by optimizing its accounts receivables and lower sales days outstanding going forward.

It is very important for Cushman & Wakefield to achieve a free cash flow conversion rate of 30% or higher, as the company needs to allocate sufficient excess cash flow to various areas.

One major area that CWK needs to allocate capital is debt paydown.

As highlighted in its Q2 2023 results presentation , the company's net debt-to-adjusted EBITDA metric has increased substantially from 2.8 times as of end-2021 and 2.9 times at the end of 2022 to 4.3 times as of June 30, 2023.

Cushman & Wakefield is now valued by the market at a massive discount to the company's key peers. CWK currently trades at a consensus forward next twelve months' normalized P/E multiple of 6.3 times (source: S&P Capital IQ ), while Jones Lang LaSalle Incorporated ( JLL ) and CBRE Group, Inc. ( CBRE ) are trading at consensus forward P/E ratios of 11.7 times and 17.0 times, respectively. CBRE and JLL's net leverage metrics are relatively lower at 0.79 times and 2.3 times , respectively.

It is reasonable to assume that CWK's valuation discount relative to peers is attributable to its relatively higher leverage ratio to a large extent. Therefore, Cushman & Wakefield needs to reduce its credit risks by lowering its net debt-to-adjusted EBITDA ratio, before its valuation gap with peers can narrow. Notably, Cushman & Wakefield emphasized at its Q2 results briefing that "the health of our balance sheet" is "a top priority", and highlighted that the company has plans relating to "optimizing our debt profile."

Another key area relating to capital allocation is potential share repurchases.

Once CWK gets its leverage ratio down to a more comfortable level of below 3 times, I think it is time for the company to consider buying back its own undervalued shares.

I mentioned earlier that Cushman & Wakefield trades at a lower P/E multiple as compared to the company's peers. Separately, CWK's consensus forward P/E metric of 6.3 times is way below the stock's historical five-year average P/E ratio of 10.4 times as per S&P Capital IQ data.

CWK's shares also appear to be undervalued based on the Price/Earnings-to-Growth or PEG multiple. Cushman & Wakefield's PEG ratio is estimated to be 0.37 times, which is calculated by dividing its P/E multiple (6.3 times) by the company's consensus FY 2024-2027 normalized EPS CAGR (+17.1% as per S&P Capital IQ data).

Therefore, potential share buybacks for Cushman & Wakefield are likely to be value-enhancing at the stock's current price levels.

Assuming that CWK can meet its free cash flow conversion goal, the company will have sufficient excess capital to be allocated to debt reduction and share repurchases.

Financial Outlook

In the preceding section of this article, I highlighted that Cushman & Wakefield could possibly enhance shareholder value by allocating the company's free cash flow to deleveraging and buybacks. These actions might help to push CWK's share price up.

On the flip side, Cushman & Wakefield's capital appreciation potential is likely to be limited by the company's poor near-term prospects.

CWK has guided for its Brokerage revenue to decrease by -20% in FY 2023, while it expects its PM/FM (Project Management and Facilities Management) revenue to increase by a low-to-mid single digit percentage in the current fiscal year. Notably, Cushman & Wakefield stressed at its Q2 2023 earnings call that its top line guidance for Brokerage "doesn't contemplate any fast recovery."

In my opinion, there is a risk that CWK's actual PM/FM revenue growth for this year falls short of the market's expectations.

Firstly, fee revenue for Cushman & Wakefield in the Americas and EMEA markets declined by -14% and -10% , respectively in local currency terms on a YoY basis in Q2 2023. CWK attributed this to "lower project management activity" at its most recent quarterly earnings briefing, which I think could be linked to weaker economic growth.

Secondly, Cushman & Wakefield noted at its most recent quarterly earnings call that some "project management work" is "short term in nature", and mentioned that "a significant amount of ad hoc work" is needed for CWK to hit the top end of its PM/FM revenue guidance. It is important to note that not all of CWK's PM/FM revenue is generated from recurring sources backed by multi-year agreements.

In other words, CWK's PM/FM business might not be resilient as expected, as outsourcing activity could still be correlated with the economy to some extent and there is a certain degree of non-recurring and short-term revenue streams associated with the PM/FM segment. This implies that Cushman & Wakefield's overall revenue and earnings for the current year could fail to meet expectations, assuming that the company's PM/FM business performance isn't as good as what one would have hoped for.

Concluding Thoughts

A Hold rating for Cushman & Wakefield is appropriate. I have a favorable view of CWK's free cash conversion targets and its potential value enhancement drivers relating to capital allocation. On the other hand, I am worried that the company's full-year financial performance might be below expectations, if its key PM/FM business revenue growth is weak.

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