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Foxtons Group Plc; Initiating Coverage – 28 May 2014

 

Company Overview:

Foxtons Group Plc is a UK-based property business that operates across three segments: sales, lettings and mortgage broking (Alexander Hall). Founded in 1981, the group has developed a reputation as a premium brand image with an almost exclusive focus upon the London market. It now operates from 49 branches in total across the capital and became a listed company after joining the FTSE 250 in a September 2013 IPO. 

Index  FTSE 250 Ticker  FOXT.L Latest Close  316.00
52 Week High 397.45 52 Week Low  227.29 P/E  23.75
Dividend Yield % 1.75 Dividend Cover  2.6 CEO:  Michael Brown
CFO:  Gerard Nieslony

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Strong Growth at Foxtons throughout First Year of Listed Life

While our tone toward many property-focused companies has turned resolutely bearish since the close of Q1 2014, Foxtons Group Plc is one of the few that we remain attracted to. As with Countrywide Plc, the group maintains a healthy balance between estate agency sales and residential lettings which should continue to support earnings growth even during the anticipated downturn in mortgage lending.

As a result, the group could be described as having an attractive hedge against the cyclical nature of the housing market while also enabling investors to avoid the capital intensity and credit risk associated with house builders and banks. In 2012, the final split of earnings between  operational segments was 44.3% attributable to estate agency sales and 52.6% to residential lettings.

Following its IPO in September of 2013, Foxtons has continued to experience strong growth in revenues and profits, aided by increasing transaction volumes within London, persistent price inflation in core markets, its exclusive focus on high value property and premium rate non-negotiable commission charges.

The group reported a 19.2% increase in turnover for Q1 2014, followed by a 53.3% increase in mortgage revenue and a 41.1% increase in commission income. It is worthy of note that earnings from residential lettings remained relatively flat with the previous year, given the stronger sale/purchase environment. However, this could be seen as testament to the cyclical / counter-cyclical relationship between estate agency sales and residential lettings demand.

Despite the positive performance, shares in the group have sold in line with those of the wider property sector after setting new highs at 401.00 pence during March this year.

Foxtons Group Plc Hourly Chart

FOXTONS

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The Road Ahead

In relation to strategy and the road ahead, management intends to maintain the group’s focus upon the premium London market during the short term, with the primary means of growth coming from the expansion of the branch network.

Over the longer term, the board sees the current pace of rental inflation continuing within both inner and Greater London. As a result, strategic expectations are for more and more London workers to be driven out into the commuter belt of the Home Counties in search of affordable property, which is an area that the group has a keen eye on when it comes to future geographical expansion.

At present, management expects to announce H1 profits at the top end of expectations when reporting first half results in August. This is while over the near term the shares are likely to remain under the influence of price action across the rest of the property/ housing sector; however, with time we expect continued growth and positive results to see the group differentiate itself from the crowd. This is positive for the longer term outlook over the shares and supports our belief that the correlations with the home builders will soon begin to fall.

In addition to a positive trading performance and a bright fundamental outlook for the group, the recent decline in the shares also appears to have had a positive impact upon the longer term outlook for the group. This is because the recent price weakness, according to regulatory filings, has seen both BlackRock Inc and Caledonia Investments increase their stakes in the group.

Caledonia Investments’s holding has now risen above the 1% threshold, while BlackRock Inc has upped its position to 13.51% of the overall group. Despite the vote of confidence in both the management team and the shares, the news is also positive for other investors. This is because smaller shareholders will benefit over the longer term from the presence of large and quality institutional investors when it comes to remuneration policies, growth targets, return of capital plans and general performance.

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Valuation, Dividend and Balance Sheet

From a valuation perspective, the group currently trades on a multiple of 23.75 X 2013 earnings, which is roughly in line with Countrywide Plc, and in our view, accurately reflects the growth potential of the business.

In relation to dividends, management have committed to a progressive policy which, given a low starting base and the business’s future prospects, should enable the annual pay-out to shareholders to grow steadily over time. The final dividend for  the 2013 year came in at 5.44 pence per share, which equates to a yield of 1.75%.

In terms of debts and general balance sheet health, the group used the primary proceeds from its 2013 IPO to become debt-free, which is positive for the future given management plans to expand the branch network. Should it encounter the need to secure financing then its lack of existing leverage will help it to do this.

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Summary

In short, Foxtons presents an attractive opportunity to leverage the supply and demand disparity in London housing. With short supply and a swelling population driving both rental rates and sale prices higher, the medium to longer term fundamental outlook  for Foxtons is sound. This is while a low to non-existent debt profile, a clear and deliverable expansion plan and competent management team add further support to the investment case for the group.

Our core attraction to the group is in the balance between estate agency sales and residential lettings. This is because, when the availability of mortgage finance begins to reduce on a broad basis, the rental market will be likely to experience an upturn in demand.

In terms of market share, our other favourite within this sector (Countrywide) is indisputably the largest estate agency and lettings business in the UK. However, Foxtons has a significant foothold in London and when the share of business within the capital for both companies is combined, investors are able to secure a meaningful exposure to the UK’s premium property market. This market is more than likely to weather the contraction in mortgage lending to individuals at the lower to mid stages of the income spectrum.

On a valuation basis, the shares are trading in line with the group’s nearest competitor, Countrywide Plc, and a number of the house builders. While we expect correlations with the home builders to reduce over the coming quarters, we feel the valuation compared with Countrywide is fair and reflective of the group’s growth prospects.

On the subject of price targets, although Foxtons is likely to maintain its correlation with the home builders for the time being, we do not currently envisage any further downside in the shares leading to a break below the 290.00 pence level. This is while our medium term price target, at 375.00 pence, implies an upside movement of 18%.

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IMPORTANT:
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