FirstService Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

FirstService Corporation (FSV) is a diversified commercial real estate services provider, primarily operating in North America. It offers services across property management and property services for a wide range of commercial, retail, and residential clients.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

FirstService Corporation (FSV) operates through two main segments:

  1. FirstService Residential (FSR): The largest provider of residential community management services in North America, providing property management services to condominiums, co-ops, homeowner associations (HOAs), and other residential communities. Services include accounting, administrative, and maintenance and concierge services.
  2. FirstService Brands (FSB): A diversified franchise management and property services group. It manages businesses in a variety of niches including:
    • Property Restoration: Servicing home and business owners with property damage recovery, repair, and reconstruction.
    • Property Maintenance: Services such as painting, cleaning, and flooring.
    • Home improvement: Franchised businesses offering services like painting.

FSR is the largest part of their business in terms of revenue and earnings. FSR provides recurring revenues through multiyear contracts and is less sensitive to cyclical trends in the market.

Industry and Competitive Landscape

  • Highly Fragmented Industries: The industries in which FirstService operates are highly fragmented, with a few dominant players. However, the markets for most of the services provided by FSB’s brands are somewhat competitive with relatively low barriers to entry.
    • This fragmentation creates opportunities for FirstService to gain market share through strategic acquisitions and organic growth.
  • Recurring Revenue Model: FSR’s primary business, residential management, provides recurring revenues through long-term contracts. This subscription-based model tends to be less sensitive to broader economic cycles.
  • Competitive Intensity: Although there is competition within each individual business line, the overall scope of FirstService operations presents a formidable challenge for a competitor to duplicate or match efficiently.
  • Growing Demand: Property services, particularly restoration and maintenance, are in constant demand due to wear-and-tear, adverse weather, and other life events. There is continuous demand for property management as new residential communities are built.

Financial Analysis

  • Revenue Growth: Over the past few years, FirstService has shown solid revenue growth, primarily driven by acquisitions. 2021 saw a rise in revenue of ~20%, with 2022 and 2023 being at 15-16% on average year over year.
  • In the first nine months of 2023, organic growth (calculated as constant currency revenue growth less acquisitions) was 3.4%. The trend of growth from the two main segments is expected to continue going forward.
  • Margins: Although the net profit margins are quite low at 3 to 4%, the operating margins for the service business are about 10 to 11%.
    • The relatively low net income margins are driven by the higher debt burden. Also, depreciation and other items such as impairment of goodwill affect the overall net margins. However, margins are showing slow but steady improvements over the past few years.
  • ROIC: The return on invested capital (ROIC) for FSR has consistently been in the mid-teens and is above the WACC (weighted average cost of capital).

  • For FSB, ROIC has shown growth in the past few years, but still lingers at high single digits, mostly around 8-9%. In general, the company’s consolidated ROIC has been growing to be above 10% over the last few years.

  • Acquisitions: FirstService has been aggressive in acquisitions. From 2004 to 2021, they have acquired 140 different firms. This is a double-edged sword because it brings additional revenue and profits while being a drag on free cash flow and a heavy debt load that limits financial flexibility.

  • As of the recent earnings call in November 2023, the CEO mentioned that they have a robust M&A pipeline with a lot of firms and are seeing a good return profile on M&A targets, hence they expect the acquisition momentum to continue. In fact, they expect 2024 to be strong in acquisitions.
  • Cash Flow: Although the company’s revenue is robust, the net cash flow is lower due to acquisitions and capital expenditures.
    • Free cash flow in recent quarters was significantly lower as they took a larger hit for working capital.
  • Debt: FSV’s debt is a large part of the overall capital structure.
  • The company has a debt-to-equity ratio of nearly 300% and a debt-to-EBITDA ratio of close to 3.2 as of the last filings, but the ratio is expected to come down over the next few quarters.

Moat Analysis (Rating: 3/5)

FirstService possesses a narrow moat due to a combination of factors: * Strong Brands and Customer Loyalty in FSR: They have been an operating for over 30 years in the residential industry, their market position is highly resilient and they have generated strong and growing revenue through long-term contracts. * Network Effects in Key Areas of FSB: Certain business lines within FSB like 1-800-GOT-JUNK benefit from the network effect because the more locations they have and the more services they provide, the more attractive they become to customers. * Switching Costs in Select Businesses: While switching costs are not uniformly high across all its divisions, in certain areas like property restoration and disaster recovery, customers are unlikely to switch providers during a time of need. Also, certain businesses with tight integration into customer workflows provide significant stickiness, such as FSR and its software business. * Economies of Scale in Service Businesses: In its property services businesses, such as restoration and maintenance, the company has significant operating scale that enables it to compete with others and retain profit margins. In addition, they have operational efficiencies built over a longer time of operations that give them an edge over the competition. However, there are a few reasons why the moat is not wide:

  • Fragmented Competition: The industry is quite fragmented and competitive, as discussed earlier, which makes it more vulnerable to competitors trying to chip away market share.
  • Easy-to-Replicate Business Models in Certain Areas: Some of the processes or brands are relatively easy for competitors to duplicate. For instance, most competitors have started to use the same low-cost locations.
  • Management Talent is Relatively Transferable: Although the CEO has been doing a decent job at the helm, most operational efficiencies or processes can be easily transferred.

Risks and Business Resilience

  • Economic Slowdown: Since a portion of their business comes from non-recurring projects such as large renovations or restructuring, if there is a recession, that business will likely slow. The company’s financial model is also heavily influenced by consumer spending so any slowdown could lead to less spending on the services offered by FSB.
  • Disasters and Severe Events: A decrease in natural disasters, though generally favorable, will decrease the demand for companies in their property restoration business.
  • Interest Rates: If rates go up, the cost of debt for FSV will also increase. The heavy debt burden will also cause increased risk during economic downturns.
  • Acquisition Integration: FSV is rapidly expanding its scale and scope through acquisitions. If they are not managed properly and the acquired businesses are not properly integrated, that could become a drag on earnings.
  • Competitive Threats: As mentioned earlier, other firms can quickly come in and copy the same processes, erode margins, and take away market share from some business lines.
  • Employee Retention: It is important for the company to retain its employees to give a consistent experience to its customers. Losing quality employees can negatively impact the business.

Despite these risks, FirstService possesses a degree of resiliency:

  • Recurring Revenues: FSR’s recurring revenues provide stability during economic downturns.
  • Diversified Business: The diversified portfolio of services within FSB enables them to navigate through different economic situations.
  • Geographic Diversification: The company has a diverse geographical presence, mainly concentrated in North America, but their expansion into Europe will provide some security going forward.
  • Strong Management: The management has experience in acquisitions and they continue to emphasize the need for acquisitions that complement the company’s strategy, as they are the ones that drive the most value for the company.

Understandability (Rating: 3/5)

FirstService’s business model is relatively easy to understand on the surface level-it provides services for the upkeep of other businesses, homes, and properties. However, there are various complexities:

  • Multi-Segment Operation: Operating a broad range of business segments and brands can be difficult to comprehend, as they all require special expertise, skill, and management. The number of different business segments and operations can make analyzing them tedious and potentially misleading.
  • Acquisition-Driven Growth: The company grows primarily through acquisitions, so a proper understanding of M&A accounting and financials is necessary to understand and analyze their reports.
  • Nuances in Revenue: Revenue for each segment is driven by different things, making a consistent forecasting process extremely difficult.
  • Debt Burden: Although the debt is a large part of the business, the cost of it is hard to quantify and evaluate how that would affect future valuations.

Balance Sheet Health (Rating: 4/5)

  • Good Revenue and Earnings Growth: FirstService has shown solid earnings growth over the past few years and their revenue and profitability are steadily improving.
  • High Debt Levels: As mentioned earlier, the company has a large debt burden, but their interest payments are still well-covered by operating earnings.
  • Growing Intangibles: A large portion of their assets is constituted of goodwill and intangible assets that are hard to evaluate and have the tendency to be written down or impaired.
  • Strong Cash Flow from Core Business: The core parts of the business like FSR continue to produce cash. While cash flow is a little limited in FSB, it has improved greatly over the past few years.
  • High Tangible Asset Base: As a primarily service-based business, their tangible asset base is smaller than their revenue stream. This is a great asset to have in terms of the business’s stability.

Overall, they have very good financials, but it is somewhat limited by the heavy debt and intangible asset base on the balance sheet.

Recent Concerns and Management’s Response

  • As discussed earlier, the debt burden is a concern and many investors have expressed that concern. The CEO mentioned on the earnings call in November 2023 that the company will look to pay down its debt by utilizing free cash flow, and is comfortable with the current debt levels.
  • Another concern was the slower organic growth than historical trends. Management has been clear that they prioritize acquisitions and focus on generating value that way while still maintaining some organic growth. They don’t expect to increase organic growth without hampering their long term strategy of acquisitions.

In summary, FirstService Corporation is a fundamentally sound company with a growing market presence and a relatively good balance sheet. It has a narrow but somewhat durable economic moat built around brands, customer lock-in, and niche markets. Investors need to be aware of the inherent risks and make informed decisions based on their needs and risk appetites.

Note, that the contents of this summary are purely for informational purposes and should not be considered as financial advice. Make sure you do your own research and due diligence before making investment decisions.