Frontdoor, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Frontdoor, Inc. is a leading provider of home service plans in the United States, primarily known for its home warranty business, but also expands into a range of services like maintenance contracts.

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.

Frontdoor, Inc. (FTDR) is a provider of home service plans, commonly known as home warranties, primarily in the United States. The company connects homeowners with a network of service professionals for repairs and replacements of home systems (like HVAC, plumbing, and electrical) and appliances (like refrigerators and washers). While most of its revenue comes from home warranty business, it is making efforts to expand into other services such as home-maintenance contracts.

Business Explanation

The company’s revenue is derived primarily from subscription-based home service plans, offering various options with different coverage levels. These plans typically generate recurring revenue streams. Frontdoor also provides a growing direct-to-consumer offering, connecting homeowners with service pros directly and also generating leads to its service network.

Revenue Distribution: The company primarily operates in the US. They have a large portion of its revenue is through the home warranty subscription business, providing consumers with a level of financial coverage against some breakdown in their home systems or appliances. They are however, trying to diversify that income by expanding into non-subscription model by becoming a platform to connect consumers and service professionals, and earn on commissions or fees generated from this marketplace. They have 3 main channels: Direct (B2C), Retail Channel (B2B), and Real Estate Channel (B2B).

Industry Trends: The home services industry is highly fragmented with several types of participants, including independent contractors, large franchise service providers, as well as other public home warranty companies. The industry is increasingly reliant on technology and consumer convenience. More customers are preferring online booking or service requests.

Competitive Landscape

Frontdoor operates in a competitive market, where companies fight to get more customers and also have higher margins. There are large public companies such as American Home Shield, Select Home Warranty, and also several smaller local players. The core challenge for Frontdoor is to create a differentiated offering that will allow to win in this competitive marketplace. The key differentiators appear to be their national brand, their expansive network of service providers, and the use of technology to enhance customer experience.

What Makes Frontdoor Different: Frontdoor’s primary differentiating factor is its wide brand recognition, with over 50 years of experience in the home warranty space. However, brands are not that powerful in this industry, and what customers want is reliable repair and a hassle free experience-which is a very easily copied process, because of that there is not enough moat. The company also is focusing on technological platform that allows to connect customers and the network professionals quickly, but also makes available data analytics and AI-based technology to better serve the customers in the long-term.

Financials Analysis

Revenue

  • FTDR reported total revenue of $1.66 billion for fiscal year 2022 a drop by 3%.
  • First Quarter of 2023 was at $379 Million, a drop of 8% YOY.
  • Second Quarter of 2023 revenue at $524 Million, a drop of 4% YOY.
  • In general the revenues are expected to stay down in short term due to the challenging home buying market.

Margins

  • Gross profit was $1.039 billion, with gross profit margin of 63% for the full year in 2022.
  • Q1 2023 Gross Profit at $219 million, a Gross Profit margin of 58%.
  • Q2 2023 Gross Profit at $318 million, a Gross Profit margin of 61%.
  • Lower margins in both first and second quarters are a result of high claim costs, while higher revenue is dependent on higher prices.

Expenses

  • Selling, general, and administrative (SG&A) expenses were 34% of revenue for full year 2022. This can be a problem and indicates low efficiency for such a developed business.
  • There have been consistent increase in costs throughout past year.
  • Management expects to improve customer retention to reduce the cost of acquisition.

Profitability

  • A net loss of $130 million was reported for full year 2022. This includes several non-recurring items such as a loss in equity investments, goodwill and intangible asset impairment, all this combined to a loss of $395 million before taxes.
  • Q1 2023 Net income was at $71 million due to a decline in the share-price, which increased other income, and higher EBITDA.
  • Q2 2023 Net income was at $33 million compared to $50 million for Q2 2022, due to lower margins.
  • Overall Profitability looks to be inconsistent and influenced a lot by non-recurring events.

Cash Flows

  • Free cash flow was negative at -$136 million. However, if we disregard the $205 in purchase of marketable assets from that, cashflow from operations is around $69 million.
  • Q1 2023 Net cash from operating activities was $212 million, and Q2 2023 net cash provided from operating activities was $146 million.
  • Despite the operating cash flow looking good, the free cash flow is still dependent on managing capex and working capital.

Balance Sheet

  • Balance sheet has a cash position of ~$434 million and a total debt of ~$1.05 billion, most of which is a term loan. The net debt position is concerning.
  • Goodwill and acquired intangibles is almost $800 million, accounting for a significant amount of total assets.
  • Shareholder Equity is negative at -$78 million due to accumulated deficits.
  • Capital spending has also increased considerably over the years.

Concerns: A significant concern is the high level of debt and negative shareholder equity, indicating potential financial vulnerability. They also have to manage high interest rates and slow house buying market.

Moat Rating: 2/5

Frontdoor possesses a narrow moat due to its brand recognition, which creates some consumer loyalty, and scale. However the company struggles in differentiating itself in the competitive market where the network effects are not very strong, and switching costs are very minimal. The services offered in home warranty are easily duplicated and because of that the moat is very weak. They are trying to increase their moat through technological superiority, but those investments are not guaranteed to pay off.

Moat Risks and Business Resilience

  • Competition: The home services sector is highly competitive with both established players and new entrants, which means that they need to keep focusing on marketing and sales activities.
  • Economic Downturns: During economic downturns, discretionary spending for home warranties and other similar services might decline as the housing market slowdowns.
  • Rising Claim Costs: Inflation has led to a spike in the cost of parts and labor, which means higher claims costs and lower profit margins.
  • Operational Challenges: They need to carefully manage their provider network, service logistics, and ensure a consistent quality of service.
  • Technological disruption: There is a possibility that new technology entrants with better technology can come in and eat the incumbents market.

Despite these risks the company has tried to build their moat by expanding their online platform, adding new services and improving customer relationship management. This helps create resilience to withstand economic or competitive pressures, by becoming better and more convenient for the customer and for the providers.

Understandability: 2/5

The business model of offering home service plans and connecting providers and customers is not especially complicated, but the financial complexity lies in understanding the value creation in a competitive market and all the factors that affect the bottom line. Also, there are many moving parts in their financials that makes it not straight forward to understand.

Balance Sheet Health: 3/5

The balance sheet shows some signs of risk with high debt and the negative shareholder equity. But they still have a substantial cash position and have positive operating cash flow. However the high debt level makes the company more susceptible to economic downturns and interest rate hikes.

This report is intended only for informational purposes and shouldn’t be considered as financial advice. Please Do you own due dilligence before investing.