Foxtons Group — New CEO targets recurring income streams

Foxtons’ new CEO has returned to the business, via a successful period at a competitor, with a clear plan to reinvigorate a declining brand and turn it back into the estate agency powerhouse that it once was. An operational review has identified past failings and focused his mind on the upgrades and changes that are needed to rebuild the business by investing in data capability, recruitment, training and incentivising staff, and re-energising the Foxtons brand. If successful, the non-cyclical Lettings business should expand rapidly, the Sales business will take market share, particularly at the higher price points, and Financial Services will grow strongly. The target is to expand the margin by c 50%, double operating profit ‘over the medium term’ and to materially increase the proportion of non-cyclical revenue from the current level of c 65%.

Guy Gittins, the new CEO, has carried out a thorough operational review of Foxtons since his arrival in September 2022 and has not only identified what he sees as the company’s medium-term growth ambitions, but has also, refreshingly, outlined what he sees as the company’s core operational failings over the last six to seven years, which have resulted in loss of market share in Sales, a missed opportunity to aggressively grow the Lettings business and a lack of investment in Financial Services. In a nutshell, the Foxton brand name has been diminished and competitors have performed better.

The key operational failings identified are:

The core operational upgrades largely reflect the four sets of failings listed above and include:

Foxtons expects the costs of the operational upgrades will be largely paid for by the cost savings generated by the removal of a layer of management and from an anticipated improved financial performance from the underlying divisions. Management hopes that the upgrades will have a material and long-term impact across the whole business. For example, in Lettings, it expects to improve organic revenue growth by 3–5% pa and to continue to execute M&A, which should target a return on capital of at least 20%. In Sales, Foxtons anticipates increasing its market share from 3.4%, back to where it was as recently as 2016, at c 4.5%, and in Financial Services, it anticipates leveraging on the Sales business to achieve compound revenue growth of c 7–10%.

Collectively, over the medium term Foxtons expects to achieve an operating margin of at least 15%, versus a reported 9.9% in FY22, and a total adjusted operating profit of £25–30m, compared to £13.9m in FY22. Although these targets may seem ambitious, they should be seen in the context of previous profits and margins. For example, in 2013, 2014 and 2015, Foxtons averaged an operating margin of c 30%, and generated an operating profit in excess of £40m in each year, so we believe these new targets are credible.

The chart below highlights the increasing operating profit generated from the non-cyclical Lettings division over the last four years. The number of tenancies and revenue have both grown at a 7.2% CAGR over the period, but operating profit has grown from £5.3m to £18.0m and, broadly speaking, has accounted for all of the growth in the group’s operating profit. Financial Services, which is c 50% non-cyclical, has also grown progressively over the period, while the highly cyclical Sales business has roughly halved its operating losses which may continue to decline if it retakes market share, as planned under the operational review.

On 6 March 2023 Foxtons announced its latest acquisition of an estate agency, which follows six other deals in the previous three years. In this move, Foxtons agreed to buy Atkinson McLeod for a total consideration of £7.4m in cash. Atkinson McLeod is described as a ‘high-quality’ estate agency operating out of a four-branch network in Central East London. In the year to March 2022, the business generated revenue of £3.1m and an operating profit of £0.9m, implying a historical sales multiple of 2.4x. The multiple is modestly higher than the 2x multiple paid for Gordon & Co in 2022, reflecting the relatively low proportion of cyclical sales revenue and the high proportion of non-cyclical letting revenue in the mix. Atkinson McLeod generated c 90% of revenue from lettings, versus c 65% for Foxtons Group.

The 1,100 tenancies in the portfolio bring the acquired number of tenancies since 2020 to c 8,100, and Foxtons’ total tenancy portfolio to c 27,500. We expect Foxtons to be able to generate both revenue and cost synergies from the deal as it is integrated into existing business, suggesting like-for-like revenue of perhaps £3.5m and an operating profit in excess of £1.5m. It is worth noting that the pure lettings book of Douglas & Gordon (D&G), purchased in 2021, generated a revenue of £11.2m in FY22, an operating profit of £5.3m and an implied operating margin of 47%, supporting the expectation that Atkinson McLeod’s operating profit will improve under Foxtons’ ownership.

We believe that Foxtons will continue to comb the market for other suitable lettings books, though further deals in 2023 may be limited given the spend in 2023 to date. That said, we believe that Foxtons will end the current year with net cash of c £8.1m, which offers the potential to execute another deal of this size if the opportunity arose. The three 2020 deals and the 2021 purchase of D&G collectively generated a return of c 34% in 2022, after synergies. Foxtons anticipates similar returns from the latest three deals, as shown below.

Despite a volatile market, Foxtons grew FY22 revenue by 10.9% to £140.3m, driven by growth in all three divisions, modestly exceeding our revised expectations. Adjusted operating profit grew 55.6%, driven largely by a c 65% drop-through rate in Lettings, offset by losses in Sales due to investment in future capacity. Overall, the total adjusted operating margin expanded 280bp to 9.9%, still some way short of its 15% medium-term target. EPS increased c 50% to 3.0p and the total dividend was doubled to 0.9p/share. Despite investing £8.4m in acquisitions, £1.5m in dividends and £4.9m in share buybacks, Foxtons ended the year with net cash of £12m, comfortably ahead of it £8–10m net cash target.

Total Lettings revenue increased 17% to £86.9m (2021: £74.3m) on the back of a 5% increase in the overall lettings book to c 26,500 tenancies. Revenue was boosted by a 25% increase in the average revenue per transaction to £4,211, offset by a 7% reduction in transactions to 20,640, reflecting tightness in availability.

Of the £12.6m increase in Lettings revenue, £7.6m was organic growth driven by a c 20% increase in average rental prices offset by longer agreed tenancies, £2m was the annualisation of the D&G lettings book, which was included for an additional two months in the year, and £3m was driven by the two lettings books purchased in May 2022. The latter will be included for an additional five months in 2023.

The Lettings operating margin expanded by 750bp, from 13.2% to 20.7%, benefiting from the operating leverage of growth, notably from the additional £11.2m of revenue and £5.3m of operating profit from the acquired D&G Lettings business. In the period, Foxtons disposed of the loss-making D&G Sales business and successfully integrated the D&G lettings book and the two businesses purchased in May 2022.

The chart below clearly shows that although the number of lettings in H122 and H222 was broadly similar to 2019, the average revenue per rental has risen by roughly a third as overall rates are now higher, and the quality of the portfolio has improved, driven in particular by the D&G portfolio.

Sales revenue rose by 1% to £43.2m, benefiting from a 3% increase in transaction volumes to 3,215, offset by a 2% decline in the average revenue per transaction to £13,431 despite an increase in the average price of properties, from £577k to £590k. The decline in revenue per transaction reflects an increase in the proportion of properties sold under the government’s Help to Buy scheme, which has now been closed. Trading in Q4 was particularly hit by the mini-budget but is now showing some signs of recovery.

Although revenue was up slightly, operating profit fell from £0.5m to a loss of £3.2m, reflecting investment in the business, including increased staff numbers, rebuilding costs and one-off property restructuring costs, plus inflation. The operating margin reversed from +1.3% to -7.5%.

The chart below shows the volume of sales, revenue and revenue per unit over the last eight half years. It shows half-yearly volumes in 2022 of c 1,500–1,700, up c a third versus c 1,200 in H119 and H219. Revenue per unit is broadly unchanged, implying that total revenue was also about a third higher in FY22 versus FY19.

Foxtons’ Financial Services division handled 5,003 units in the year, which was marginally up on FY21. Revenue and revenue per transaction were both up 8%, to £10.2m and £2,043 respectively, due to a 6% increase in mortgage activity from higher average fees and an increase in loan size, and a 2% increase in protection volumes. Of the £10.2m total revenue, £4.5m was from non-cyclical refinance activity and £5.7m was from more cyclical purchase activity.

Operating profit in the segment increased c 20% to £1.8m and the margin expanded by 100bp to 17.3%. Over the last eight half years, volumes and revenue per transaction have both trended modestly higher, which has steadily pushed total revenue up. Financial Services remains the smallest division of the group by a long way, but it is a profitable and complementary component of Foxtons.

Our underlying estimates are unchanged post the prelims, bar for the 10-month inclusion of the Atkinson McLeod acquisition in FY23, and a full 12-month inclusion in FY24. We assume revenue in both years increases by £2.1m and £3.0m respectively, and that operating profit benefits from a £0.5m contribution this year, including some integration costs, and by £1.2m in FY24, benefiting from a full year contribution and some synergies. Net cash declines in both years, reflecting the £7.4m total estimated cost of acquisition.

Our ‘base’ case valuation rises from 53p/share to 59p/share with the inclusion of the latest acquisition. However, our preferred valuation methodology in our ‘bull’ case attempts to reflect market share gains across all three divisions in line with the revised strategy, which we believe is likely to result in an increased headcount. It also attempts to reflect some value for yet-to-be-announced M&A and an increase in the recurring, non-cyclical lettings and remortgage activity. M&A has been a strong feature of the group for the last three years and is likely to remain so given its strategy, its financial strength and the opportunities that exist. The additional c £24m of revenue assumed over and above the FY24 estimate of £146.5m is driven by market share gains, assumed M&A and growth from the Build to Rent sector. We have then assumed a c 65% drop-through rate to which we apply a 17.5x price to earnings ratio. The implied earnings lead us to our revised 124p/share ‘bull’ case valuation, up from 118p.