FSV:CC - FirstService: This Underfollowed Gem Has Been Outperforming For Years

2023-12-23 03:18:07 ET

Summary

• FirstService is a market leader in outsourced property services, specializing in property management, maintenance, and related services.
• With dominant market positions in several industries operating recognizable brands with geographical reach, the company has a scale advantage that enables it to achieve both organic and inorganic growth.
• FirstService has a long-term track record of growth, with a 19% CAGR in revenues since 1995 and a 17% CAGR over the last five years.

Please note all $ figures in not , unless otherwise specified

Investment Thesis

FirstService Corporation ( FSV:CA ) (FSV) is a market leader in the outsourced property services industry. With a modest market share in various fragmented markets including serving homeowner associations, landscaping, providing security services, and managing repairs and renovations, the company has been performing steadily. Having significantly outperformed the market over its life as a public company, the company's market dominance and scale advantage in fragmented industries have been instrumental in its success. Despite its higher valuation multiple, I believe the current multiples are justified given its track record.

Business Overview

FirstService is a leader in outsourced property management, maintenance, and other services to property owners in North America. Its services to both residential and commercial properties can include everything from managing homeowner associations (HOAs), providing onsite security services, and repairs and renovations

First Service segments its revenues into two main parts: FirstService Residential and FirstService Brands. FirstService Residential, which makes up 45% of company revenues , is the division of the company that provides property management services for the residential space. These services are often for large residential communities who usually require services to manage homeowner associations, condos, and co-op housing. Most of these services are usually re-occurring in nature and include financial management, maintenance, landscaping, and security services.

The second segment is FirstService Brands, which has been the faster growing of the two segments, and contributes 55% to total company revenues. Essentially, this segment services both commercial and residential properties but through a network of franchisees and company-owned brands. Often, many services in the space don't have recognizable brand names and are independents. However, through this segment, FirstService has several recognizable brand names that do painting, HVAC, plumbing and more.

One point about the company I found interesting was its track record of growing revenues at a high rate of return over the long-term, growing revenues at a 19% CAGR for the last 28 years. Even over the last 5 years, this CAGR doesn't look bad at 17%, suggesting the company really isn't showing signs of slowing down. With more than half of this growth being organic, rather than acquisitive, it's clear that demand for FirstService's offerings is on the rise.

And its long-term growth rate shows up in its share price performance too. Since June 2015, FirstService has delivered a return of 532%, outpacing the return of the TSX's 36% return. In terms of its share price performance, it's been one of the best non-resource stocks over this period.

A key part of FirstService's success has been due to its proven business model and market position. FirstService operates in several fragmented markets like HVAC, painting, and plumbing. These industries tend to be led by small, independents who might usually get referrals through word-of-mouth and don't operate under recognizable banners. As small companies, they often face challenges in scaling, standardizing services, and accessing resources efficiently.

This is where FirstService comes in. With dominant market positions in these industries operating familiar brands with a larger geographical reach, FirstService has a scale advantage that enables it achieve both organic and inorganic growth. With its market dominance, it achieves factors like scale and brand recognition that are tough for smaller players to achieve.

The industries in which FirstService operates also tends to be exceptional businesses, in that they have steady and re-occurring sales. Some of the services they offer are also critical. After all, you're not going to skip out on repairing HVAC systems or delay when you need to get your plumbing done. In my view, this is likely a reason why larger properties tend to stick with FirstService, having multiple repairs, installations, and other services being required on a regular basis year round.

Recent Developments

When looking at FirstService's Q3 2023 earnings , revenue was up 16.3% to $1.12 billion for the three month period and adjusted EPS was up 6.8% to $1.25 per share. The lower growth in EPS is mostly as a result of higher interest rates.

Much of revenue growth we are witnessing is being driven by the FirstService Brands segment which grew 20%, partly as a result of strong growth from restoration brands. FirstService Residential saw lower growth up 12% but this was right in line with management's expectations. With new contracts added to the portfolio, this division also saw more revenues from management fees and labor-related revenue.

Looking beyond the quarter out over the next few years, I expect FirstService to put up similar numbers going forward. Interestingly, about half of the FirstService Brands Segment was organic growth and organic growth was up 9% for the Residential segment. To me, this indicates that the company leveraging its current businesses and brands to grow revenues, by winning new customers and maintaining old ones. Moreover, by introducing supplementary services to their current offerings (such as incorporating alarm services into their sprinkler businesses), FirstService has the potential to significantly increase the average spend of a typical customer.

When looking at FirstService's balance sheet, the company had a little over $450 million of cash. It had a Net Debt to EBITDA ratio of 1.5x, an improvement from 1.6x a year ago. First Service also saw an improvement in its Debt to Equity ratio which was 0.79x, an improvement from 0.84x in 2022. These metrics suggest that FirstService is not highly leveraged and can in fact support a higher debt load should it want to pursue strategic opportunities like M&A.

And in fact, subsequent to the quarter, it did make a pretty sizeable M&A transaction. With the acquisition of a controlling interest in Roofing Corp of America just this week for US$413 million, First Service has made a huge purchase, a departure from the small tuck-ins we're used to seeing. This acquisition is a transformational one for FirstService, particularly for its brands in property repair, maintenance and restoration. It'll also serve as a platform for the company to enter the roofing business, an adjacent and related service to the other property management services it provides. The company has stated that the transaction will be funded through both cash and its revolving bank facility which brought total borrowing capacity to US$1.25 billion.

Up until the end of Q3 (before the major acquisition), the company had done over $110 million in acquisitions. So while this may translate to a slower pace for acquisitions next year, I view this transaction as signifying that FirstService is seeing opportunities to acquire new businesses and longer-term, believe the company will still be able to pursue acquisitions. That said, going forward, it will be important to monitor leverage ratios as well as ensure that FirstService doesn't overpay for its acquisitions.

Valuation

When looking at analysts price targets, the analyst community had an average price target is $195.22, with a high estimate of $220.34 and a low estimate of $184.45. From the average, this suggests that analysts are seeing 11.3% downside.

No question about it, FirstService is an expensive stock to own at 43x Price to Earnings. When annualizing the adjusted EBITDA figure for this quarter, the stock is still trading at 20x EV/EBITDA.

However, in my view, I believe FirstService's valuation is justified. Given that the company has grown both revenues and EBITDA at CAGRs of 17 and 19% over the last 28 years, I believe the company can still grow in the mid-teens for the foreseeable future. I also believe that being a high quality company with an exceptional record, a premium multiple is justified.

When looking at the historical EV/EBITDA range for FirstService, the company's shares have traded within a range of 14x to 30x EV/EBITDA. At 20.3 EV/EBITDA, the company looks to be trading close to the average over this time, so it seems that on a historical basis FirstService shares look fairly priced. For investors wanting to get in at a better price, a target closer to under 18x EV/EBITDA would be a decent target, or a share price sub CA$190.00.

Conclusion

In summary, FirstService has proven itself as a compounder that has put up fantastic growth in both revenues and earnings. The consistent double-digit revenue growth, coupled with the recent acquisitions and organic expansions, shows FirstService's commitment to scaling its operations efficiently. In my view, while its valuation may appear high at first glance, the company's historical growth (which I believe should continue) and its market dominance justify this premium, making it a compelling investment opportunity. I would rate the stock as a buy today at the current price.

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