Description

Foxtons (FOXT) is a good company available at a cheap price due to short-term uncertainty over Brexit.  The company is the leading real estate agency in London with roughly ½ of its business focused on sales and the other ½ on rentals.  The rentals business provides a stable source of revenue to withstand market cycles and the company spits off and returns a large amount of cash to shareholders – for example 27% of the current market cap has been returned via dividends and buybacks in the last 3 years since its IPO.  Foxtons has a long runway to continue to open new branches at high rates of return, a dynamic that depresses short-term earnings but acts as a tailwind over time as the branches mature and reach normalized levels of profitability.  Despite these attractive characteristics the stock is down -36% this year and -70% from its 2014 highs – while Brexit will certainly have an impact in the short-term, looking out several years I believe this is a very attractive entry point.

Background

Foxtons was founded in 1981 and has steadily grown into the leading real estate agency in London.  The company serves the higher end of the market and commands premium pricing, charging 2.5% vs an average of 1.5% for its peers.  In recent years the company has been able to maintain its pricing and its market share, despite increased competition from both traditional agencies (Countrywide, Savills, LSL, etc.) and tech-enabled hybrids like Purplebrick:   

*source: UBS

Below are links to previous write-ups of Countrywide and LSL that in aggregate give a great overview of the space. While I believe there are several interesting opportunities in the space today (see valuations over time below), Foxtons has several things that I like in particular including its 1) focus on London, 2) large % of revenue from rentals, 3) tailwinds from its recently opened stores maturing over time and 4) strong cash generation and willingness to return it to shareholders.

https://www.valueinvestorsclub.com/idea/Countrywide/131690#description

https://www.valueinvestorsclub.com/idea/Countrywide_PLC/1501

https://www.valueinvestorsclub.com/idea/Countrywide_Plc/137499

https://www.valueinvestorsclub.com/idea/LSL_Property_Service/120745

https://www.valueinvestorsclub.com/idea/LSL_Property_Services_PLC/62831

*UBS

Growth “J-Curve”

Foxtons has 63 branches throughout London and adds 5-10 new locations a year (typically around 7).  On average new branches become cash flow positive after 7 months, pay back the upfront investment in 20 months, and reach mature profitability within 5-7 years:

*Foxtons company presentation

Over ½ of the company’s current branches have been opened since 2010 and it’s highly likely these recently opened branches are under-earning their potential but will become more profitable as they continue to mature.

Valuation and Brexit

Foxtons is debt free with an enterprise value of £329 million.  Each of the last 3 years the company generated between £32 and £35 million in net income and returned the majority of that to shareholders.  Earnings will be down this year and likely next as well, but the company will continue to add new branches and its existing branches will continue to mature, increasing its long-term earnings power.  The impact of Brexit makes precise forecasting next to impossible, but as one data point consensus earnings for 2016 are around £20 million, leaving the stock at a P/E of 16x.

Regarding Brexit, I would encourage you to read the recent Brexit-related VIC write-up and discussion from July, as well as several other datapoints that suggest that the fears over Brexit may be over blown:

https://www.valueinvestorsclub.com/idea/FTSE_250/138714#description

http://www.bloomberg.com/news/articles/2016-09-01/u-k-factories-rebound-from-brexit-shock-as-pound-boosts-exports

http://www.telegraph.co.uk/property/house-prices/house-price-growth-defies-post-brexit-gloomy-forecasts---but-wil/

http://www.businessinsider.com/when-will-article-50-be-triggered-2016?r=UK&IR=T

To be clear I think this is an asymmetric bet regardless of one’s view of the above and the stock is currently pricing in a “bad” scenario, although Brexit and the broader economy will clearly have an impact on when this works.  If there is a bad economic scenario lasting several years, the company should be buffered by its rental business and has several levers to control its costs, including cutting employee costs and delaying spending on new branch openings.  During the financial crisis when there was a 50% decline in housing transactions, FOXT’s EBITDA margins fell to 12% but rebounded strongly in 2009 to 26%.

Risks

Brexit uncertainty is clearly a short-term risk, although over the long-term I think the larger risk is from “hybrid” competitors that offer lower fees and will likely create downward fee pressure on the entire sector.  A company called Purplebrick has been gaining share, raised capital in an IPO, and even has a similar market cap as FOXT despite a fraction of its revenues (and large losses).  Clearly there is some demand for a lower priced, “hands on” model, but I believe FOXT is relatively well positioned given its focus on the higher end London market where customers are likely more willing to pay for the convenience of a “high touch” model.  FOXT management maintains that they have no plans to cut their rate but given the current valuation I think there is room for it to come down and for the investment to still work.  Finally there is a lot of competition in the space, with groups like Countrywide and Savills putting up a good fight, but FOXT is the clear leader in an attractive niche of the market, with a strong brand and a management team with a history of strong execution.

Catalyst

• Continued cash generation and returns to shareholders
• Continued branch expansion and maturation of recently opened branches
• UK economy and London real estate market return to normal (eventually)