Can Homeserve Fix Your Portfolio?

Homeserve is a global provider of home maintenance and repair services and is the owner of various quality-checking websites for trades people such as Checkatrade in the UK. Homeserve is listed on the London Stock Exchange and is a constituent of the FTSE 250. Its core markets are the UK, the US, France and Spain. However, Homeserve also has operations in Canada and a joint venture with Mitsubishi Corporation in Japan. Homeserve has been quite the British success story, with its shares up nearly 3000% since the company came to market in 1993. Since Homeserve put its mis-selling troubles behind it in 2011, performance has been aided by its buy-and-build strategy, where Homeserve has expanded its reach in the service and repair markets in verticals such as HVAC (heating, ventilation and air conditioning). Much of its recent growth has been driven by their US business, where Homeserve has carved out a significant tranche of the insured home repairs market through acquisitions and a sprinkling of organic growth. With this potential opportunity to continue to grow into the vastly under-penetrated US market, Homeserve hopes to offset disappointing performance in its more mature market in the UK. Does this potential growth prospect combined with the recent 30% drop in the price of Homeserve shares present a good opportunity to invest?



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History


Homeserve was established by Richard Harpin in 1993 as a joint venture between his own company Fastfix and South Staffordshire Water, which offered an emergency plumbing service. In 1994, the company diversified its offering to plumbing and drainage policies under the name HomeServiceScheme. In 2001, Homeserve entered the French market by launching its French subsidiary Doméo, and in 2003, Homeserve entered the US market with a subsidiary named Home Service. In 2004, a water service business unit was de-merged from the overall group and the name of the company was changed to HomeServe PLC.

After launching in various European and North American markets, Homeserve focused on acquisitions to boost scale in its respective markets. Some notable acquisitions have been the purchase of property repair company Reparalia in Spain in 2007 and the French warranty provider SFG in 2009. In North America, HomeServe made a series of acquisitions, including National Grid's service contract business in the United States in 2010, Utility Service Partners in 2016 and Dominion Products and Services in 2017.

From 2010 onwards and throughout the decade, Homeserve launched and acquired a handful of businesses in both Germany and Italy, but due to limited successes in those markets, the group has since divested its interests.

In more recent years, Homeserve has also been pursuing a strategy of buying online trade recommendation platforms such as Checkatrade in the UK, Elocal in the US and Habitissimo in Spain. These platforms allow users to find recommended specialists in their respective trades and also allows for trades people to advertise their services. Whilst these platforms currently play a small role compared to Homeserve’s main revenue source, they are part of Homeserve’s strategy moving forwards.


Business Model


Homeserve splits its business into three specific units: Membership, HVAC and Home Experts. The membership segment of Homeserve offers customers an insurance-style service, where paying members have access to a trusted service person to fix household issues such as plumbing and faulty electrics. Homeserve’s HVAC unit is responsible for the installation and service of heating and air conditioning systems, which represents their largest venture in the US. Lastly, Home Experts is the business segment that houses all of the trades comparison branded websites such as Checkatrade or eLocal.



Homeserve typically sources membership customers through long-term, exclusive partnerships with utilities, insurance companies and specialist service providers. The company has a network of over 1,000 utility partners and has considerable expertise in managing these partnerships for mutual benefit. Homeserve’s utility partners earn commission on every policy they secure through them. HomeServe acts as an insurance intermediary, and therefore it does not take any material insurance risk, with Homeserve membership products underwritten by independent, third party underwriters.


Recent Performance


Homeserve published its full year 2021 results (year to 31st March) on May the 18th. Homeserve has also recently provided a brief trading update to the market on the 16th of July, which largely reiterated guidance set in the full year results.


For the full year to March 2021, Homeserve posted fairly resilient results despite being in the midst of the pandemic. Revenues were up 15% for the year, boosted by several acquisitions across all geographies, but on an organic basis, there was more muted growth at 4.3%. Retention rates (a key performance indicator for Homeserve) nudged up one percentage point to land at 83% of customers during the year.



Adjusted operating profits at Homeserve grew 6% to £214 million, delivering an adjusted operating margin of 16%. On an unadjusted basis, operating profits slumped 55% during the year compared to 2020, largely due to the exceptional cost of decommissioning its company CRM system (eServe) to a newer, more flexible system. This cost Homeserve nearly £100 million during the year, but management insist it is money well spent and an important investment to remain flexible in future years.



The above graph displays Homeserve’s recent performance from a geographic/business unit basis. For each geography, both Membership and HVAC are included in each result. The UK has been troublesome for Homeserve over the last few years and 2021 continued this trajectory. As Homeserve’s most established market, poor performance here provides a drag on the overall business. The UK business has faced customer drop off and higher levels of competition than in other markets where Homeserve is the dominant force. Whilst a 9% drop in revenues here isn’t desirable, the group has brought in John Kitzie to head up UK operations — previously, John was the CEO of the successful North America division. Both France and Spain delivered solid results during the year with mid single digit growth (Homeserve has strong partnerships with utility providers in this region and thus growth here has been typically slow but reliable). Results in North America were very positive, up 9% on an organic basis and 22% on a reported basis boosted by great performance in the HVAC segment as homebound Americans took to installing and servicing their air-conditioning units.


The Tale of Two Markets


Over the last few years, there has been a notable shift in direction at Homeserve. The UK, which was Homeserve’s first and largest market, was surpassed by the US recently in terms of both revenue and profits. For investors, much of the investment case rests on the likelihood that Homeserve can continue to grow in North America.


As one can see from the below graphics, the structural set up for North America represents a large opportunity when compared to the UK. In the UK, Homeserve estimates only 15% of households are unserviced, with British Gas being the main provider of membership and servicing to households followed by Homeserve. In the US, 60% of households operate with no servicing or insurance provision, to which Homeserve now represents the largest provider of services to the US market, followed by smaller competitors such as American Water.



Not only does Homeserve see a large opportunity in terms of space to grow into in the US market, but also, especially in the HVAC division, Homeserve sees an opportunity for bolt-on acquisitions. In 2021, Homeserve undertook 7 HVAC acquisitions in the US. This tends to be a highly fragmented market, with lots of small vendors in the HVAC space, thus it provides an optimal hunting ground for value-enhancing acquisitions.


There are signs Homeserve is making good headway in North America, particularly displayed by its overall customer retention rate, which rose two percentage points during the year to 85% — above the company average of 83% and much higher than the UK’s 78% retention rate. With well-penetrated markets like France displaying a retention rate of 88%, I think there could be continued scope for Homeserve to strengthen its customer retention in the US.


In the UK, performance has been dwindling for years, and whilst Homeserve has employed the ex-North America CEO to lead the turnaround, I am hesitant to view the UK as a future growth driver for the business, especially when the division has lower profit margins than much of the group. Homeserve’s acquisition strategy is evidence of this de-prioritisation. During 2021, only 1 HVAC acquisition was made in the UK versus 24 made in other geographies. Whilst Homeserve probably doesn’t need growth in the UK to justify its long term investment case — as the US alone could provide a very healthy future profit stream — it would be ideal if management could stem the flow of customer drop-off and so reduce the drag on the overall business.


New leadership here is key, and the heavy investment in CRM systems combined with a focus on digital customer acquisition will hopefully progress the turnaround. However, I think the story here is un-concluded.


Home Experts


Despite Homeserve’s somewhat rudimentary business of servicing boilers and fixing air conditioning units, the business also owns various online platforms designed to identify quality trades people. Most of these platforms are in their relative infancy and the Home Experts business unit has been growing fairly quickly, with organic growth of 24% in 2021. eLocal, which was acquired in 2019, is the largest platform Homeserve owns, delivering £91 million in revenue in 2021. eLocal also had adjusted operating profits of £18 million during the year showing the potential for these asset-light platforms to generate solid profits for the group.



The UK’s Checkatrade also had a strong year, with 23% growth in website visits during the year and revenue of £19 million. However, despite the boost from lockdown-related trade requests, the website produced an operating loss of £16 million. Habitissimo, the Spanish trade platform, which is currently the smallest in Home Expert’s division, suffered with poor conversion during the year and a small decline in revenue from £11 to £9 million.


Whilst these platforms currently represent only 10% of revenues for Homeserve, I'd expect them to provide profitable returns in the future, strengthened by network effects and time to build their reputations within their respective markets. This provides optionality for the business model, whilst being serviced from a light cost base.


Acquisitions


Imperative to Homeserve’s growth strategy and the investment case is their acquisitions. Under a buy-and-build strategy, Homeserve looks to acquire smaller businesses to bulk out their offerings, improve scale and efficiencies across a broader base, and also, seeing as their retention rate sits at 85-88% in some of their core markets, Homeserve can buy customers by purchasing companies with a large number of policyholders on their books.


As a more cautious investor, the word ‘acquisition’ typically gives me reason for concern, as many businesses fail to deliver value for shareholders when buying businesses. So, looking into Homeserve’s cash flow statements over the last 5 years should give some clarity around a few important things to consider when buying a serial acquirer like Homeserve.



The chart above depicts Homeserve’s cash flow over the years 2016-2021. Each line represents an important aspect of the acquisition process. Firstly, ‘Free Cash Flow’ in blue lets us know exactly how much cash has been left over after operating costs to spend on things such as acquisitions. The red bars display how much cash the business has spent on acquiring such businesses. The yellow bar for 'Amortisations' shows how much the business has ‘written off’ the value of intangibles from these acquisitions (meaning the value of these assets no longer represent their current value for the business). Lastly, the green bars for ‘Issued Share Capital’ show how much capital has been raised through share placings on the stock exchange.


In an ideal world a business would acquire companies with cash remaining in free cash flow, buy assets that need little amounts of amortisation and very rarely issue new share capital as this is dilutive for shareholders.


Whilst this would be the perfect situation, the type of business I would steer away from is the type that is regularly buying businesses that exceed free cash flow, alongside frequent equity placings and a high amount of intangible amortisation. In addition to this, if organic growth is also stagnant, acquisitions are not likely adding value to the core business.


In Homeserve’s case, I think the acquisitions are of merit. Out of the 6 years above, acquisitions have only exceeded free cash flow 50% of the time, and even then, the largest year for asset purchases was 2020 with £140m of purchases. Considering Homeserve now has a market capitalisation of over £3 billion, I would view these purchases as small bolt-ons. Only one large issue of share capital has been made in the last 6 years, with a placing of £123 million shares (net proceeds) in 2018. Whilst the other acquisitions have likely been funded with a mixture of cash flow and debt, Homeserve remains fairly under-leveraged at 1.8x net debt to Ebitda. Whilst the level of amortisations has been creeping up in recent years as the business makes larger purchases, amortisations are part of a natural process in acquiring — so long as they remain fairly manageable at less than £50 million, this presents no real concern for a business as large as Homeserve. Lastly, looking to the earlier charts of organic growth, whilst Homeserve is growing through acquisitions, the growth of the underlying business has been pretty solid too, showing that once businesses are added to Homeserve’s umbrella, they continue to thrive. Overall, I would view Homeserve’s acquisition strategy as manageable and effective to continue building value for shareholders.


Summary and Valuation


In summary, I think Homeserve is a good quality business with a large opportunity available to it in the US market, which it is in the early stages of penetrating. A turnaround in the UK could be on the cards, but at a minimum, a stemming of the flow of membership redemptions is required to maintain the financial health of the business (this should be a key watch out for investors in the coming half year results.) The business also has some optionality and future asset-light growth potential with its online trade review platforms, which could provide a lucrative profit stream for the business in the coming years.


Looking at valuation, Homeserve's shares are currently trading at 24 times this year's earnings and 20 times expected earnings for Homeserve’s next financial year 2023. Having derated nearly 30% from its mid 2020 heights, I think it looks like a good opportunity to buy a quality business at a reasonable price.


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At the time of writing, The Twenties Trader did not own shares in Homeserve.


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