Value Investors Club / BOYD GROUP INCOME FUND (BYD.UN)

Description

How would you like to own the only publicly-traded company in a rapidly consolidating space at a discount to

recent private equity transactions? From 2006 to 2016, Boyd was the best performing stock on the TSE. Despite this already outstanding result, I believe there is more upside left in the shares.

At the price of C$84.00, the shares trade for ~11x 2018E EBIT. Using 2017 estimates, I calculate the shares trade

for ~12x EBITDA, whereas a competitor was recently purchased for 15.2x pro forma adjusted EBITDA.

The North American auto repair market is highly cash generative and recession-resistant as repairs are non-

discretionary and mostly paid for by insurance companies. Boyd has the opportunity to continue to grow same store

sales from increased repair spending but mostly from market share capture and additional acquisitions of single sites

and multi-shop operators (MSOs).

Business Description

Boyd is an operator of 362 non-franchised North American collision repair centers. These body shops provide repair

services to insurance companies, individual vehicle owners and fleet/lease customers. Two other smaller businesses

consist of retail auto glass operations (42 centers) and a third party claims administrator (Gerber National Claim

Services*) which acts as a middleman between the customer and the fleet management and insurance segment for

emergency roadside assistance (i.e. first notice of loss, glass and other services). These smaller units account for

10% or less of revenues. The Canadian listing is a misnomer as >90% of Boyd's revenue is from its US operations.

*GNCS cites 5,500 and 4,600 affiliated glass provider locations and emergency roadside service providers.

For the main business of collision repair, the drivers of revenue include accident frequency and the cost of repairs.

Both claims frequency and repair severity has climbed as a function of increased miles driven, congestion,

additional registered vehicles and more distracted driving (https://www.wsj.com/articles/smartphone-addicts-behind-the-wheel-drive-car-insurance-rates-higher-1487592007). The severity of damage has also risen due to more

sophisticated automotive technology and complexity in new cars (high recent SAAR means more new cars which

means increased claim severity and higher likelihood of repair; collision avoidance technology is an offset).

Insurance

The key advantage Boyd maintains over smaller players is access to Direct Repair Programs (DRPs). These are

preferred programs (i.e. referral arrangements) with insurance companies that drive volume to more sophisticated

national body shop networks. It is a symbiotic relationshipas companies like Boyd offer insurers higher customer

satisfaction, quicker repair times (reduced length of car rental) and lower average cost of repairs through economies

of scale and best practices (e.g. repairs higher percentage of damaged parts versus replacing). As a result, insurance

carriers recommend these locations to customers looking for a body shop after an accident. These national, regional

and local DRPs provide an opportunity to drive market share wins as insurers seek to consolidate repairs with fewer

shops to reduce cost and complexity and add consistency.

From the insurer’s perspective, this is an important point of contact with the customer. Many customers view the

repair process as an extension of the insurance company. A significant portion of customer satisfaction with the

insurer is determined during this phase. A good result (high quality and quick turnaround) leads to better customer

retention, which ultimately reduces customer acquisition costs for the insurer.

To explain the process a bit further, I’ll provide an example. The average driver gets into an accident every seven

years. The claims process begins when the driver calls his/her insurance carrier. In most cases, the insured selects an auto body shop from a list of recommended centers provided by the carrier as part of its DRP. In many cases, instead of sending out an adjuster, the shop completes the estimate and paperwork for the insurer. Immediately or shortly after the repairs are completed, the insurance company remits payment to the body shop. Again, being part of these programs allows Boyd to win share at the expense of smaller operators and to rapidly increase volumes at newly-acquired shops. The acquired shops also benefit from re-branding, new contracts with vendors replacing existing arrangements and general operational improvements.

Industry

US collision repair spending is expected to increase ~1% annually over the next five years (per CCC). This is

slightly lower than recent trends. The breakdown of this spending is as follows: Labor (45%), parts (41%), paint

and other materials (10%) and other miscellaneous (4%).

The collision repair industry is highly fragmented. Most shops are small independents - family-owned or single site

operations. In recent years, the trend has been slightly growing total collision revenue* spread over a few number of

shops. For example, in 2006, total sites approximated 45,000 compared to ~33,000 today. Over the same timeframe,

revenue per site rose almost 50%. Large MSOs control an estimated 21.5% of the US$36+ billion market but

account for only ~6.5% of total locations. This results in plenty of remaining consolidation opportunities. Outside of

Boyd, the larger players include Service King (Blackstone and Carlyle), Caliber Collision (OMERS and Leonard

Green) and Abra Auto Body & Glass (Hellman & Friedman).

*Comprised of paint and body repair (~80%), glass repair and replacement (~10%) and other.

Why do smaller players sell?

There are several reasons but a few include reduced volumes as larger MSOs gain market share, required capital

expenditures due to more complex jobs (including aluminum repairs where equipment can cost $50,000-$100,000) and succession issues.

More on Company

Boyd added 58 locations in 2016 and reported same store sales growth of 5.3% compared to 5.6% and 7.2% in 2015

and 2014, respectively. This compares to the 5-year and 10-year averages of 4.7% and 4.5%. The company has

reported 16 straight quarters of same store sales growth. The average Boyd facility (including glass operations)

generates approximately 3x the revenue compared to the industry average.

For new shops, Boyd employs the "Wow Operating Way" initiative to drive operational process improvements,

specifically cycle times and customer satisfaction. These best practices are rolled out to all new locations within a 3-

9 month timeframe. Due to relatively high fixed costs, incremental volumes show a high contribution margin. As

such, gross margins at mature stores are higher compared to new or recently-acquired sites. As these newer facilities age, we should see overall margins improve.

In recent years, Boyd added more corporate development resources to help drive M&A activity. Management's

growth target is to double the business over the next five years (started in 2016) through same store sales,

acquisitions and new site development (e.g. 7 start-ups and brownfields added in 2016). Boyd targets 25% pre-tax

ROIC (defined as EBITDA/invested capital – implying 4x pro forma EBITDA). Typically, larger MSOs sell for ~7x

EBITDA whereas single sites receive 4x-5x (seller’s) EBITDA. When rolled into a larger system, the multiples are

estimated to be ~2x lower on a synergistic basis after factoring in incremental volumes, improved vendor terms

(parts, paints, rental cars, etc.) and the upgrading of under-invested facilities.

The business is capital light as most repair facilities are leased and maintenance capital expenditures are estimated at ~0.8% of sales. Additionally, this industry operates with negative working capital due to short-term receivable

cycles from insurers*. This serves as another source of cash flow as the company grows. Therefore, Boyd’s

acquisitions are largely funded with internally-generated cash.

*In general, an estimated 50% of receivables are collected before the car leaves the shop, with the remaining received in <1 month.

Capital Structure

The capital structure is straightforward. Total debt of C$171 million is comprised of bank borrowings (C$33

million), convertible debentures (C$58 million - captured in dilute share count), seller notes (C$68 million) and

capital leases (C$12 million). The company is conservative and the balance sheet is under-levered (<1x) relative to

peers leaving significant “dry powder” (>C$350 million) for acquisitions. Management indicated comfort with net

leverage of ~2x.

Total shares outstanding consist of two components - units outstanding (publicly-traded) and Boyd Group Holdings

Inc. ownership of A shares which can be exchanged for units. There is a good description of this in the annual report.

Total diluted share are 19.6 million for an enterprise value of C$1.7 billion.

Net Debt C$60 million (convertible bond captured as equity)

Minority Interest C$29

Market Capitalization C$1,650 (0.7% dividend yield)

Enterprise Value C$1,739

Financials

The shares sold off after the 4Q conference call when management guided to “very modest” same store sales growth

in 1Q due to warm and dry weather*. In 4Q, SSS grew 4.5% and the company reported revenue and EBITDA of

C$360 (+15% yoy) and C$33 million (+14% yoy), respectively. For the year, Boyd reported 30 bps improvement in

EBITDA margins and 210 bps since 2012 to ~9%.

*An estimated 40%-50% of US collision locations are in markets experiencing this weaker weather-related demand.

Previously, management mentioned EBITDA margins could exceed 10% at the right levels of utilization. In 2006,

opex as a percentage of sales was 39.1% compared to 36.8% in 2016. This margin improvement should continue in the years to come.

I calculate that current run-rate EBITDA plus modest same store sales growth and acquisitions similar to 2016 results in 2017E EBITDA of ~$146 MM. Netting out normalized maintenance capex* leaves UFCF of $134 million. Rolling the numbers forward a year and factoring in additional acquisitions gives me EBITDA and UFCF of >$170 and >$155 million, respectively.

*2017 guidance of $25-$28 million accounts for IT infrastructure and specialized equipment (aluminum repairs) relating to new technologies.

Valuation

Using the 2018 numbers, the shares trade for 11x UFCF. I think this is a cheap creation multiple considering the

inorganic and organic expansion opportunities plus expected same site growth totaling in the mid-teens. Another source of potential value is the untapped balance sheet. Boyd is clearly under-levered. Compared to other players, the balance sheet offers the opportunity to complete a large transaction or a series of smaller deals without having to raise equity.

On its most recent call, the CEO noted the purchase of a minority stake in Caliber Collision for 15.2x a “generously adjusted normalized EBITDA.” This is not far off from other similar transactions. Service King, owned by Blackstone and Carlyle is reportedly expected to generate “upwards of $2 billion” in a sale process that was reportedly initiated. If we capitalize EBITDA at a 15x multiple, the shares are worth over C$105/share and C$125 if we roll forward a year. At 12x 2018E EBITDA, the shares are worth ~C$100.

Risks

1. Declines in insurance claims as a function of reduced collisions and repairable automobiles

Crash avoidance technology expected to reduce accident frequency by ~20% over the next 25-30

years but spending per accident expected to partially offset

Collision avoidance technology, driverless vehicles and other safety improvements; if every car

went autonomous (100%), it would take 15+ years to replace existing fleet

Increased replacement of more complex technology rather than repair which has higher margins

2. Roll-up model

The roll-up model is often questioned but in this space it works well as larger players have years of experience

consolidating and a distinct competitive advantage relative to smaller competitors.

3. SAAR, general economic conditions (unemployment) and miles driven (higher gas prices)

4. Loss of DRP relationships (top five insurance customers represent 49% of sales)

5. Integration issues; ability to retain technicians

6. Increasing competition for acquisitions; scarcity of medium-sized MSO deals

7. Declines in used car prices which insurers tie to their “actual cash value” (ACV) calculation. This makes it

more likely a “total loss” will be declared leading to more non-repairs (~15% of accident classifications)

8. Multiple compression

9. Canadian dollar strength

10. Equity issuance to fund acquisitions

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

-Acquisitions

-Sale of Service King providing another private market valuation data point

-Takeout by private equity? Merger with PE player (back door listing for currently private player)

show sort by

			2017	2018
Price:	84.00	EPS	0	0
Shares Out. (in M):	20	P/E	0	0
Market Cap (in $M):	1,650	P/FCF	16.6	14.5
Net Debt (in $M):	60	EBIT	134	156
TEV (in $M):	1,739	TEV/EBIT	13.0	11.1