KFSYF - Kingsway Financial Services: EBITDA And Debt Are Improving But It Looks Expensive

2023-06-22 00:27:39 ET

Summary

• The company has been pivoting to its Kingsway Search Xcelerator program and TTM EBITDA has surpassed $15 million.
• In addition, asset sales over the past year have enabled Kingsway to reduce net debt to $35.8 million as of March.
• However, I’m concerned Kingsway hasn’t added a new company to KSx for over 7 months and that interest expenses reached $3 million in Q1 2023.
• Kingsway is trading at 17.5x EV/EBITDA and I don’t plan to open a position here at a valuation of above 12x EV/EBITDA.

Introduction

At Microcap Review, we like to write about micro-cap stocks on SA, and today I'm taking a look at Kingsway Financial Services ( KFS ). It’s a US holding company with a portfolio of extended warranty businesses which is pivoting to a business model that reminds me of Berkshire Hathaway Energy (NYSE: BRK.A ) (NYSE: BRK.B ) whereby it’s buying small and profitable businesses run by early-in-career managers. In my view, it’s an interesting concept and financial results have been improving rapidly. Yet, Kingsway is starting to look expensive based on fundamentals and my rating on the stock is neutral at the moment. Let’s review.

Overview of the business and financials

Kingsway was founded in 1989 as a specialty insurance company that pursued a rapid growth strategy. It specialized in niche areas such as long-haul trucking, high-risk drivers, risk protection for U.S. home builders, and California artisans and gross premiums written soared from $659.5 million in 2001 to $1.85 billion in 2007. However, the company booked significant losses during the Great Recession when it turned out that many of its insurance contracts were significantly mis-underwritten.

Kingsway then embarked on a restructuring plan and pivoted to the extended warranty services sector (mainly cars) with the purchase of IWS in 2012, Trinity Warranty Solutions in 2013, Professional Warranty Services in 2017, Pen Warranty and Prime Autocare in 2019, and Preferred Warranties in 2020. It also had a portfolio of real estate properties. In 2021, Kingsway launched a CEO Accelerator Program which was later renamed Kingsway Search Xcelerator (KSx). It focuses on investing in asset-light growing businesses run by young CEOs that have recurring revenues and high margins. Since then, Kingsway has bought three companies under the KSx program - outsourced accounting and human resources services provider Ravix Financial for $11 million in 2021, financial executive services firm CSuite for $8.5 million in November 2022, and healthcare supplemental staffing agency Secure Nursing Service for $10.9 million also in November 2022. The three companies were bought at between 4x and 4.5x EV/EBITDA and I find it encouraging that the revenues and EBITDA of Ravix have improved significantly under the ownership of Kingsway.

It seems that Kingsway is now focusing on its KSx program as the company sold PWSC and most of its real estate business between July 2022 and February 2023. Kingsway used most of the proceeds from the disposals for the repurchase of trust preferred debt (TruPs) at just above 60 cents on the dollar.

This has enabled Kingsway to significantly strengthen its balance sheet, with net debt falling from $305.3 million in 2021 to just $35.8 million in March 2023. The company has a carrying value of $11.8 million related to the remaining TruPs debt instrument. In my view, it’s likely that Kingsway will repurchase the last TruPs tranche by the end of 2023.

Looking at the Q1 2023 financial results, revenues increased by 17% year on year to $26.4 million while the adjusted EBITDA soared by 134.7% to $2.4 million. The key driver behind the improved profitability was the improved results of Ravix as well as the addition of CSuite and Secure Nursing Service as the adjusted EBITDA of the KSx segment rose by 93.3% to $1.7 million. This brought the TTM revenue and EBITDA of this segment to $24.9 million and $4.6 million, respectively, which means that it now accounts for a quarter of total revenues and almost a third of EBITDA. Overall, the TTM EBITDA of Kingsway stands at $15.2 million at the moment and the company says that the run-rate is about $18-19 million.

Turning our attention to the valuation, Kingsway has an enterprise value of $266.3 million as of the time of writing and is trading at an LTM EV/adjusted EBITDA ratio of 17.5x. While this number seems high, it’s worth noting that Kingsway has a $610 million net operating loss carryforwards (NOLs) (see slide 8 here ) and adjusted EBITDA has been growing at a compound annual growth rate [CAGR] of 31% since 2018. The businesses in the KSx segment are being bought at below 5x EBITDA, which should bring down the ratio significantly over the coming years. The company is targeting two to three new acquisitions per year that generate annualized adjusted EBITDA in the range of $1.5 million to $3 million each, which means that EBITDA could grow by up to $9 million per year over the next years. Also, Kingsway approved a $10 million share buyback in March 2023, and this could provide a boost for the share price in the coming months.

That being said, it remains to be seen whether the financial results of CSuite and Secure Nursing Service improve as fast as the ones of Ravix have and I’m concerned that Kingsway could be struggling to find more businesses for its KSx platform considering no new companies have been added to it for over 7 months now. In addition, I think that debt continues to be an issue as interest expenses soared by 117.9% to $3 million in Q1 2023 due to rising interest rates, which means that Kingsway can’t benefit much from the NOLs at the moment.

Investor takeaway

Kingsway has significantly reduced its net debt over the past year and the financial results of its KSx segment are encouraging as TTM EBITDA has surpassed $15 million. Yet, I’m concerned that the company hasn’t added a new company to its KSx platform for over 7 months and that rising interest rates have pushed quarterly interest expenses to $3 million. Overall, I think that Kingsway is on the right track in its pivot to KSx as the new businesses are being bought at below 5x EV/EBITDA. The company is on my watchlist, but I wouldn’t open a position here at a valuation of above 12x EV/EBITDA due to the significant risks present.

For further details see: