Description

Summary

Belvoir Group (BLV) is one of the largest property franchisors in the UK. BLV is a resilient business with 26 years of consecutive earnings growth, high margins and low capital needs. The company has been growing FCF per share at 15-25% per year, while also paying a 4.5% dividend yield. At a 10% 2023 FCF yield with a net cash balance sheet, BLV provides an attractive opportunity for small funds and personal accounts.

Business background

BLV started out in 1995 as a pure-play lettings franchisor. Over time they complemented the business with estate sales and financial services. Today, BLV operates 338 franchised offices under six different regional brands: Belvoir (159 offices), Northwood (91), Newton Fallowell (39), Nicholas Humphreys (20), Lovelle (16) and Mr and Mrs Clarke (13). They also operate a network of 284 mortgage advisors.

At its core this is a franchise business. BLV derives 80% of its gross profit from royalties paid by their property franchisees. BLV provides them with central support (e.g. a known brand, operational best practices, back-office, training and certifications, valuation and rental data/services, regional advertising and assistance in doing acquisitions) in return for a 10-12% royalty fee of the monthly revenue. As most know, franchise businesses possess attractive features with recurring revenues, high incremental margins and little capex.

BLV’s franchisees are largely local entrepreneurs with 100% skin in the game. The majority operate just one to three offices. There are no large established franchisees as is the case with the major hotel and fast-food chains. The £150-200k start-up costs of running a BLV office, means that the franchisees generally have put all their money into the business. Alignment of incentives on the operating level doesn’t get much better than this. This is why the franchisees consistently outgrow the industry by a few percentage points. When the first lockdown ended, it took some of the corporate estate agency chains two months to reopen, while BLV’s franchisees opened their doors on the first day possible.

The company reports into two divisions, property franchising and financial services. The former can be split between lettings and estate sales.

Lettings (60% of gross profit). This is by far the best part of the business. Lettings is the managing of residential property on behalf of a landlord. This includes finding a tenant, doing the related administration/compliance, property visits and managing the tenant relationship. The franchisees charge landlords 1-1.5% of the monthly rent. Through its franchisees, BLV manages 75.5k properties, up from 37k in 2015. This segment has been growing gross profit at a low teens CAGR (incl. M&A). Lettings is a resilient business as people have to pay rent no matter the state of the economy. Organic growth has been positive every year since inception.

Estate sales (20% of gross profit). The business of selling houses, which clearly is not as attractive as lettings. BLV’s franchisees charge a 1% commission on the value of the house. BLV sold 11k houses in 2022, up from 7k in 2017. Like lettings, gross profit has been growing at a low teens CAGR (incl. M&A). This segment is less cyclical than the overall housing market as they have historically grown above market, continue to attract new franchisees and generate 93% of gross profit outside of the Greater London area (less prone to boom and busts cycles). In 2022, BLV saw a 11% decrease in housing transactions compared to a 15% drop for the overall UK housing market.

Financial services (20% of gross profit). BLV manages a network of 284 mortgage advisors. The majority of them (85%) are self-employed. While technically not a franchise business, it works similarly. BLV provides central support and leads in return for a 25% cut of the fees. BLV works with one of UK’s leading mortgage intermediaries, the Mortgage Advice Bureau (MAB). MAB offers BLV access to >90 lenders, looks after compliance and processes the mortgages. The typical mortgage fee is 0.3% of the amount borrowed. In terms of cyclicality, this segment sits between lettings and estate sales. More than 90% of mortgages in the UK are two to five years in length, after which it typically gets refinanced. As such, there is a stable stream of mortgage renewals each year. Around half of the segment is refinancing-related and the other half is tied to housing transactions.

Industry overview

The UK counts 4.6m private-rented properties and sells 1.2m houses in a normal year. The majority of these are managed and sold by one of the more than 20k estate agencies/lettings offices. At least 15k of these are independents. The rest consists of agency networks that range from a handful of offices to in the hundreds. The largest networks include Connells (1,250 offices), The Property Franchise Group (438), BLV (338), LSL Properties (300), Dexter (80) and Foxtons (60). Connells, Dexter and Foxtons are all company-operated networks (i.e. no franchising). The latter two only focus on London. LSL’s offices used to be largely company-operated, but they started to convert these to franchisees earlier this year. The Property Franchise Group is most comparable with BLV as they also have a large franchised network. The main differences are that they skews more towards estate sales than lettings and generate 20% of revenue from company-operated offices.

The UK mortgage market is also fragmented with 6k mortgage advisory firms and more than 15k mortgage advisors. Around 85% of all mortgages are sold through intermediaries like MAB. This is up from 60% in 2005 and The Intermediary Mortgage Lenders Association expects this to reach 90% by 2024.

Investment thesis

As a franchisor, BLV’s main job is to attract new franchisees and support existing ones to grow their business. Historically, BLV added 7-10 new franchisees per year (2-3% office growth) and organically grew the average revenue per office with a few percent per year. However, the majority of growth comes from acquisitions, both at the franchisee and at the corporate level.

Acquisitions at the franchisee level are especially attractive because it’s capital-light. BLV has an in-house acquisitions team that helps franchisees with acquiring competitors (e.g. sourcing leads and arranging the financing), but does not have to lay down a single dime for these deals. Since 2014, their franchisees acquired 130 businesses. This can be either a competitor’s whole office or only the lettings book. Management targets >£6m in acquired franchisee revenue per year, or £0.6-0.8m in high-margin franchisee fees for BLV (3-4% of total gross profit). I believe this to be conservative as the company already acquired ~£7m in franchisee revenue in 2018 and 2019 with a smaller network.

In addition to the franchisee acquisitions, BLV typically closes one to two deals on the corporate level each year. They acquire small networks of lettings/estate agencies (15-20 offices) and recently some networks of financial advisors. They historically paid 5-6x trailing earnings. In the earlier years, BLV financed some deals with equity. But since 2016, they used internally generated cash flow or debt. The majority of deals are sourced from relationships. The owner typically comes along and keeps running the business and uses some of the proceeds to buy BLV shares.

Since 2015, the company grew both the number of offices and royalties earned per office by 6-7% per year. In 2016, they also build up their financial services segment, bringing total gross profit CAGR to 17%. Roughly 5-6% is organic and 10-12% comes from M&A. Given that royalty revenue comes at high incremental margins, EBIT margins (EBIT/gross profit) expanded from 28% to 45%. EBIT compounded at 25% CAGR and FCF per share at 22%. There are several reasons to believe that the next 5-10 years should be similar or even better.

First, the market remains fragmented with more than 15k independents and a large tail of small networks. BLV can continue their playbook for many years with plenty of acquisition opportunities both at the franchisee and at the corporate level. The company sits on a net cash position for the first time since 2015. The CFO mentioned to be willing to go up to 2x EBITDA if the right opportunities arise. Increasing leverage to this level, frees up £21m (~25% of the market cap). At the historical acquisition multiple of 5-6x earnings, this has the potential to boost earnings by up to 50%. Last week, management told me that they were very optimistic on completing a few corporate acquisitions this year.

Second, the UK government is expected to introduce the largest regulatory change to the residential lettings sector in decades that should accelerate consolidation. The “Renters (reform) Bill” was introduced to Parliament last month and is expected to come into law in 2024. In short, the bill will increase compliance/legal requirements for landlords and introduce an ombudsman covering all landlords. If a tenant rents through a letting agent, then they have by law access to a free property ombudsman scheme who can fine an agent for up to £25k in case of wrongdoing. This is currently not yet the case if rented through a private landlord. These changes make outsourcing to an agent for only 1% of the rent an increasingly attractive option. With around half of the rental properties managed by private landlords this has the potential to be a meaningful tailwind. Furthermore, increasing compliance standards hit smaller agencies harder than larger ones who can centralize the legal/compliance support.

Third, after years of only 1-2% rental inflation rates, rents across the UK are rising at more than 10% on new tenancies and 3-4% on existing ones. The main driver is inflation, but there are also structural reasons that support higher rental rates. The UK rental market is a story of high tenant demand but not enough supply. The number of privately rented properties have doubled since 2002, but remained flat since 2016. This is mainly due to a list of flawed policies (higher stamp duties, phasing out of mortgage tax relief and more stringent requirements placed on landlords). This caused some landlords to exit the market and others to raise rents in light of higher operating costs. The rising house prices and mortgage rates provide further support for higher rental rates. The average tenant stays around 3-4 years in a house, meaning that we will gradually see the impact of higher rental rates flow through the P&L over the coming years. Needless, to say this comes at are very high incremental margins. We already start to see this with +7% organic gross profit growth in lettings in the first four months of 2023.

Valuation

BLV trades at an 10% 2023 FCF yield. This assumes housing transactions to decline 10% to 1-1.1m (below the historical average of 1.2m), lettings to grow MSD, £3m of acquired franchisee revenue that are already closed YTD and reflects the new 25% corporate tax rate. I did not factor in any acquisitions on the corporate level, which could easily add 10-20% to FCF on a pro-forma basis.

I believe there are a few reasons why this opportunity exists. First and foremost, this is an illiquid £81m micro-cap. Second, there is only one broker covering the stock and that is sponsored research. Lastly is the effect of being a micro-cap + UK + housing-related business in the current environment.

The thesis is not reliant on BLV re-rating to a higher multiple. FCF per share growth of 15-25% combined with a 4.5% dividend yield, already makes for an attractive IRR. I believe BLV deserves at least a mid-teens FCF multiple. However, I don’t see a near-term catalyst for this to happen. If BLV continues to build their public track record along with a higher market cap, more coverage and improved liquidity, they will probably attract more investors and re-rate over time. But I view this as a cherry on the pie.

Management

BLV is led by Dorian Gonsalves. He is with the company for over 17 years and CEO since 2011. Prior to joining BLV, he worked at Countrywide. Mr. Gonsalves owns 2% of the shares directly and close to 3% including options (6x total annual compensation). Aside from owning a few letting properties, all his wealth is tied up in BLV shares. The CFO, who is with the company for over 9 years, owns another 2%. Management increased their holdings over the past 12 months by purchasing shares on the open market. Half of management’s compensation is variable with a hurdle of a 15% EPS CAGR over a three-year period. I have talked to the CEO and CFO a few times and they come across as good operators that really understand their business well. Like with many UK micro-cap management teams, they could improve on the capital allocation front. For example, by offsetting dilution and opportunistically repurchasing shares when their view of the business differs widely from the market’s like it did last year during the mini-budget debacle.

Risks

Cyclicality

While BLV operates in the housing market, 70% of its gross profit is recurring (lettings + the remortgaging part of financial services). Only 30% is exposed to the ups and swings of the housing market. Housing transactions on a three-year stack were in line with the historical average and prices have risen by around 20% since the pandemic. Some argue that these prices are not sustainable, while others say they are because of the large housing supply shortage. I have no special insight into what the housing market would look like over the coming years. However, even if house prices would revert to pre-pandemic levels, this would only be a 6% impact on total gross profit. BLV can easily grow through this with one or more acquisitions. When housing transactions declined by 15% in FY22, earnings were still slightly up. And this was with only modest acquisition activity (~40% of FCF). The company proved resilient, growing earnings in each year since inception in 1995.

Disruption from online players

I don’t believe this to be a real risk, yet it’s worth discussing. Unlike in the US where you pay a commission of 5-6% of the property value, the UK has one of the lowest commission rates among developed countries. BLV’s franchisees only charge a 1% commission and work on a no sell no fee basis. BLV’s average property value is £200-220k, meaning a £2-2.2k commission. The largest online agency, Purplebricks, charges a fixed fee starting from £999 + £700 for optional viewing services, both needs to be paid regardless whether a sale occurs. A (former) Jeffries analyst claimed that Purplebricks only sold 50% of the advertised properties. I don’t know any UK online player that turns a profit. Several already went out of business and Purplebricks was recently sold for £1.

Aside from the above, the potential risk of online disruption is largely limited to estate sales. Lettings is less susceptible since the majority of work in lettings is in managing the relationship after the tenant moved in. Online platforms help with documents and generating leads, but it generally stops there.

Online agencies account for roughly 5-10% of total estate sales, which has been stagnant for years. Per Rightmove, UK’s leading residential real estate portal, market share of online players did not even increase during the pandemic. If not then, when? For most people their house is their biggest asset and they are happy to pay a little bit more to have some personal connection and help along the way.

Catalyst

• BLV continuing their playbook
• Announcement of new acquisitions