| FIRSTSERVICE CORPORATION (FSV, Toronto) (FSRV, NASDAQ) |
| RESEARCH
SUMMARY |
| Report Author(s): |
InvestorsFriend Inc. Analyst(s) |
| Author(s)' disclosure of share ownership: |
Author(s) do hold shares |
| Based on financials from: |
March '06 Y.E. +Q2 '07 |
| Last updated: |
22-Dec-06 |
| Share Price At Date of Last Update: |
$23.42 |
| Currency: |
United States $ |
| Current Rating (Company Rating does not consider the
circumstances of any individual investor and is therefore not a
recommendation and is not Investment Advice): |
(higher) Buy rated at U.S. $23.42 |
| DESCRIPTION OF BUSINESS: (fiscal 2006 figures published June
2006) Active in 4 segments - 1. Residential Property management (3000
properties, 550,000 residential units) 33% of operating profit , 2. Security
services 6% of operating profit, (video monitoring systems and guard
services), 3. Property improvement - 28% of operating profit - home painting,
install closet organizers, home inspections, 4. International Commercial real
estate brokerage service 32% of operating profit. The company has over 16,000
employees. Revenue is 64% U.S., 22% Canada and 14% international) The
business has grown through numerous acquisitions. Grows internally and by
acquisition. Focuses on businesses with low fixed costs higher variable cost
with low capital expenditure needs, recurring revenue, strong cash flow and
high returns on invested capital. In June 2006 announced a large acquisition
in the mortgage field, which may form a new division. |
| RATING: The graph of
earnings per share growth indicates that this qualifies as a great company.
The historical growth and profit ratios are very strong. The valuation ratios
overall suggest a Buy. Does reasonably well on the Buffett tenets. Insider
trading signal is positive. We think the exceptional business fundamentals
and competitive advantages make this worth watching. We like their business
model of acquiring private companies (which historically have tended to be
available at discounted prices) and folding them into a publicly traded
vehicle. The founder / CEO has done a tremendous job growing the company on a
per share basis over the years. It may not be a bad idea at all to continue
to tag along with him. There is no dividend which may be reasonable given the
historic growth. (They have invested earnings wisely). Given the reasonable
valuation and given the strong management, we rate this a (higher) Buy. Note
that Canadian investors face currency risk if our dollar rises. Also earnings
could stall if a recession develops. |
| RISKS:
For a full discussion of risks see the annual report. I am not aware of any
unusual risks, other than that the company would likely face a lack of
continuity if the founder and CEO was ever to suddenly die or become
incapacitated. |
| INSIDER
TRADING / INSIDER HOLDING: Checking insider trading from May 1, 2006 through
Dec 22, 2006. Several insiders exercised options and kept all of the acquired
shares, in 1 case 24,000 shares were kept and none sold, despite the high tax
bill that would result from the exercise. However about four insiders sold
some shares. Checking insider holdings there is a long list of insiders
holding shares and certainly most of these were not selling in the past six
months. The corporation itself had been quite active in buying back shares
until July. It then was not buying but resumed buying on Dec 18, 2006.
Overall we consider the insider trading/ insider holding signal to be
moderately positive. |
| WARREN
BUFFETT's TENETS: Passes some of Buffett's tenets but also fails some key
tenets (see Robert Hagstrom's book - The Warren Buffett Way) - reasonably simple to understand although it
is in multiple businesses and growing more complex (marginal pass), very good profit history
(pass), favourable prospects for above average returns (pass), apparently
candid ethical management (pass), high ROE (pass), but not high profits on sales
(fail) , reasonable debt ratio (pass), probably only moderate chance of
permanent loss of capital (marginal pass), low level of ongoing maintenance
capital spending to maintain current operations excluding growth (pass) and
arguably selling at a moderate discount to intrinsic value if one assumes
continued strong growth rates (marginal pass) |
| MOST RECENT EARNINGS AND SALES TREND: In 2006 there was a large
unusual gain that sharply boosted the GAAP earnings. (we focus on adjusted
earnings which have grown at 17.5% the past five years, but were flatter in
fiscal 2006). Quite possibly the adjusted earnings figure is conservative
since it ignores all earnings on discontinued operations, not just the
unusual gain). In Q1 fiscal 2007, the adjusted earnings per share rose a very
strong 34%. In Q2, adjusted earnings per share grew at 13%. |
| VALUE AND GROWTH RATIOS: Price to book ratio is somewhat
unattractively high at 2.76 and note that much of the book value is goodwill.
However book value is not very relevant for a service company like this. Note
that on "raw" earnings the value ratios would look very good but we
have used adjusted earnings which deducts a very large unusual gain on the
sale of a division in fiscal 2006. Adjusted earnings may be conservative
because it deducts all earnings on discontinued operations, not just the
unusual gain. Adjusted P/E at about 20 seems moderately unattractively high.
P/E based on projected fiscal earnings is slightly better at 18.4. Adjusted
Return on Equity is strong at 15.6%. Historic growth in revenue per share was
outstanding and steady at an average 17.3% and recently accelerating.
Historic growth in adjusted earnings per share has been very strong, as the
graph indicates, averaging over 17% in the past five years . Intrinsic value is calculated as $23.54 to
$29.39 based on growth of 10% to 15% and a moderate P/E contraction to 18. In
this case the intrinsic value is relatively more reliable due to the steady
past growth - but the intrinsic value if fully dependent on our growth
assumption. Overall the value ratios indicate a very strong company which
appears to be fairly valued to 20% under-valued. Overall these ratios
indicate a Buy rating. |
| SUPPORTING RESEARCH AND ANALYSIS |
| Symbol and Exchange: |
FSRV, NASDAQ and FSV, Toronto |
| Currency: |
Canadian $ |
| Category: |
Growth |
| Contact: |
Lynda Cralli 416-960-9500 |
| Web-site: |
www.firstservice.com |
| INCOME AND
PRICE / EARNINGS RATIO ANALYSIS |
| Latest four quarters annual sales $ millions: |
$1,254.1 |
| Latest four quarters annual earnings $ millions: |
$69.3 |
| P/E ratio based on latest four quarters earnings: |
10.4 |
| Latest
four quarters annual earnings, adjusted, $ millions: |
$36.8 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: Management provides
adjusted figures, earnings from continuing operations and a recent adjustment
for an unusual temporary amortization of the value of a customer list which
is arguably not a "real" expense (It is akin to goodwill
amortization, and goodwill is no longer amortized under accounting rules). |
| Quality of Earnings Measurement and Persistence: High quality,
earnings are earned in cash. Adjusted earnings which ignore earnings on
discontinued operations, may be somewhat conservative for that reason. |
| P/E ratio based on latest four quarters earnings, adjusted |
19.6 |
| Latest fiscal year annual earnings: |
$69.5 |
| P/E ratio based on latest fiscal year earnings: |
10.4 |
| Fiscal earnings adjusted: |
$32.3 |
| P/E ratio for fiscal earnings adjusted: |
22.4 |
| Latest four quarters profit as percent of sales |
2.9% |
| Dividend Yield: |
0.0% |
| Price / Sales Ratio |
0.58 |
| BALANCE SHEET
ITEMS |
| Price to (diluted) book value ratio: |
2.76 |
| Quality of Net Assets and Book Value Measurement: A large
portion of the assets are intangible. Further, FirstService is trading at a
significant multiple to book value. The value of Net Assets would likely
provide very little protection of value if earnings ever evaporated or failed
to grow as expected. |
| Number of Diluted common shares in millions: |
30.3 |
| Controlling Shareholder: Controlled by President and founder Jay
Hennick through multiple voting shares. |
| Market Equity Capitalization (Value) $ millions: |
$708.7 |
| Percentage of assets supported by common equity: (remainder is
debt or other liabilities) |
34% |
| Interest-bearing debt as a percentage of common equity |
92% |
| Current assets / current liabilities: |
1.6 |
| Liquidity and capital structure: Good, the current ratio is good
and the debt level is moderately high but manageable. |
| RETURN ON
EQUITY AND ON MARKET VALUE |
| Latest four quarters adjusted (if applicable) net income return on average equity: |
15.6% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: |
15.2% |
| Adjusted (if applicable) latest four
quarters return on market capitalization: |
5.2% |
| GROWTH RATIOS,
OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE |
| 5 years compounded growth in sales/share |
17.3% |
| Volatility of sales growth per share: |
Strong, steady growth |
| 5 Years compounded growth in earnings/share |
36.9% |
| 5 years compounded growth in adjusted earnings per share |
17.5% |
| Volatility of earnings growth: |
Strong, steady growth |
| Projected current year earnings $millions: |
$38.4 |
| Projected price to earnings ratio: |
18.4 |
| Over the last five years, has this been a truly
excellent company exhibiting strong and steady growth in revenues per share
and in earnings per share? |
Yes! |
| Expected growth in EPS based on adjusted fiscal Return on equity
times percent of earnings retained: |
15.2% |
| More conservative estimate of compounded growth in earnings per
share over the forecast period: |
10.0% |
| More optimistic estimate of compounded growth in earnings per
share over the forecast period: |
15.0% |
| GROWTH
OUTLOOK: Historic sales per share growth rate is a steady 16% and historic
earnings per share growth rate is a relatively steady 21%. It seems
reasonable to assume that the company can continue to grow at 10 to 20%. |
| Estimated
present value per share: We calculate
$23.30 if adjusted earnings per share grow for 5 years at the more
conservative rate of 10% and the shares are then sold at a P/E of 18 and
$29.09 if earnings per share grow at the more optimistic rate of 15% for 5
years and the shares are then sold at a P/E of 18. Both estimates use an 8% required rate of
return. |
| ADDITIONAL
COMMENTS |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry
rather than any particular company.) Michael Porter of Harvard argues that an
attractive industry is one where firms are somewhat protected from
competition. This industry has few
barriers to entry, although possible scale is a barrier (marginal pass). No
issues with powerful suppliers (pass). No issues with powerful customers
(pass), No viable substitute products in that the work has to be done (pass),
Limited tendency to compete excessively on the basis of price because this is
not a complete commodity product and is not a high fixed cost product but
still a strong level of price competition exists (marginal pass). Overall
this industry seems about neutral in attractiveness. |
| COMPETITIVE ADVANTAGE: Strong proven and disciplined management.
Management of operating subsidiaries are part owners, heavy use of
performance based compensation, lower operating costs based on scale and
process improvements, strong opportunities from cross selling services to
,managed apartments, disciplined acquisition strategy with strict criteria
that have been proven to work in past. I believe it has some advantage in a
disciplined approach to acquisitions. Their strategy of allowing the vendors
to continue to run acquired businesses may be attractive to many vendors. |
| RECENT EVENTS: In early 2006 divested of a major division
(Resolve business services) for a large gain. In June 2006 announced a large
acquisition in the mortgage business. |
| ACCOUNTING AND DISCLOSURE ISSUES: Generally, the disclosure
seems good, they focus strongly on EBITDA and revenue and on growth of those
figures. However, there are some concerns...
In the press release the cash flow statement is for year to date
rather than for each quarter. This is non-standard and confusing. Also in the
cash flow statement there is a large cash flow belonging to minority owners
that should be deducted before evaluating cash flow to common shareholders.
In 2006 they divested of a major division (Resolve business services). In the
five-year summary, historic net earnings are not affected. But, bizarrely,
historic revenues are restated to exclude resolve. The company then trumpets
a large increase in revenue when in reality the revenue growth was (while
still large) much smaller than indicated. Presumably accounting rules force
this presentation, but we think it is wrong to re-state history like that
especially without always making it very clear the comparison is to re-stated
numbers. Apparently, no Q4 report was
produced and Q4 was essentially not discussed in the annual report. Partly
due to this. we were unable to reconcile the annual adjusted earnings figure
to the quarterly numbers. They have a view of what constitutes adjusted
earnings but like most companies, they do not include the adjusted figure in
the five-year summary, which is annoying. |
| COMMON SHARE STRUCTURE USED: The company uses multiple voting
shares to insure the founder remains in control. The positive aspect of this
is that it provides stability and owner managed firms tend to do well. The
down-side is that management would be impossible to remove if they (he)
became incompetent. Overall, given the exceptional performance of management
to date, this share structure is not a concern. |
| MANAGEMENT QUALITY: Very high quality as proven by remarkably
consistent past results and their disciplined approach. We liked the concise
annual report and a lot of language in there that sounded like the CEO is
trying to duplicate Warren Buffett's approach to buying simple cash
generating businesses and keeping the current management and insuring those
managers keep an equity stake. Like Buffett, they also tend to keep their
acquisitions for the long term, they are not usually flippers. We are big believers
in copying from the best in any field, so we like this. On the other hand we
noted some concerns under disclosure. |
| EXECUTIVE COMPENSATION: The CEO's 2006 reported compensation at
about U.S. $2.5 million is somewhat higher than we would like to see, the
other executives are paid much more modestly. Bonuses are well related to
performance. Interestingly, there were no bonuses in 2003 when earnings
growth faltered (but earning still grew a bit). Bonuses were not much
increased in 2006 despite the great year. So perhaps there is hope that
salaries will not continue to spiral to the sky. Overall, we are not
particularly concerned by the executive compensation level. |
| BOARD OF DIRECTORS: Directors and officers own a significant
number of shares which keeps their interests aligned with other investors.
The board is small and well qualified and is effectively controlled by the
President and founder. |
| Basis
and Limitations of Analysis: The following applies to all the companies
rated. Conclusions are based largely on achieved earnings, balance sheet
strength, earnings growth trend and industry attractiveness. We undertake a
relatively detailed analysis of the
published financial statements including growth per share trends and our
general view of the industry attractiveness and the company's growth
prospects. Despite this diligence our analysis is subject to limitations
including the following examples. We have not met with management or
discussed the long term earnings growth prospects with management. We have
not reviewed all press releases. We typically have no special expertise or
knowledge of the industry. |
| DISCLAIMER:
All stock ratings presented are "generic" in nature and do not take
into account the unique circumstances and risk tolerance of any individual.
The information presented is not a recommendation for any individual to buy
or sell any security. The authors are not registered investment advisors and
the information presented is not to be considered investment advice to any
individual. The reader should consult a registered investment advisor or
registered dealer prior to making any investment decision. For ease of
writing style the newsletter and articles are written in the first person.
But, legally speaking, all information and opinions are provided by
InvestorsFriend Inc. and not by the authors as individuals. InvestorsFriend
Inc. itself does not have a position in any of the indicated securities while
the authors may have a position. |
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