Foxtons Group plc (FOXT) Earnings Call Transcript

Good day, and welcome to the preliminary results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Nic Budden, Chief Executive Officer of Foxtons. Please go ahead, sir.

Thanks very much, and good morning, everyone, and thank you for joining us for our 2019 results call. I'm joined today in the room by Richard Harris, our CFO; Patrick Franco, our COO. And as usual, we'll be all available after the formal presentation for questions, should you have any. The focus for today, obviously, is our 2019 results, and I'll begin shortly by providing an overview of performance before handing over to Richard to go through our financials in more detail. But I know you'll all be interested in getting a current up-to-date market outlook and the extent of any Boris bounce that we're seeing following the clear election result in December. So I'll provide more color than usual perhaps on this throughout the presentation where I can. What I can say is that despite a number of continuing challenges in the marketplace, we have certainly seen improving confidence among buyers and sellers during the first 8 weeks of the year. And we are starting to see this reflected in some of our lead indicators, such as applicant registrations and the sales of a pipeline, both of which are up significantly on this time last year. More of that later, but can I turn to Slide 4 now for a summary of 2019 performance? It won't be any surprise to anyone to realize that it was a relatively challenging year across the business. As expected, the tenant fee ban implemented in June impacted the lettings business; and in sales, we saw an intensification of political uncertainty ahead of Brexit and the General Election, which further weakened an already fragile sales market. Against that background, we delivered a robust performance in both lettings and sales, enabling us to limit the impact of the unhelpful market conditions on group revenues, which fell just by 4%. The decisive actions we took on cost throughout the year helped protect profitability, and we delivered adjusted EBITDA of GBP 2.5 million, just GBP 1 million below previous year. Richard will run you through the effects of the accounting policy changes that we've made on our financial metrics later in the presentation. The lettings business continues to consistently deliver for us, with revenue marginally below last year of GBP 65.7 million despite the GBP 2.7 million negative impact of the tenant fee ban, which I'm pleased to be able to report was significantly mitigated through increased volume and revenues from landlords. And we believe this outturn justifies our decision to hold landlord fees stable following the ban in June. Sales commissions fell 10% from GBP 36.2 million to GBP 32.6 million, driven by a combination of lower volumes and revenue per unit. Our sales volumes were down 4%, but with Land Registry data for the first 3 quarters showing exchanges down 11%, we're pleased to have delivered strong market share growth. A 6% decline in revenue per unit on sales was largely due to a change in the mix of our sales, which, last year, included a higher proportion of slightly lower-value homes, reflecting strong performance in the sale of Help to Buy a new property. Revenues at Alexander Hall, our mortgage broker, grew 3%, with particularly strong growth in remortgage volumes. Our balance sheet remains strong. We have no borrowing and cash of GBP 15.5 million. In line with our policy, the Board has taken the decision not to pay a dividend at this stage. In terms of current strategic focus, we're continuing to run the business prudently for prevailing market conditions while ensuring that our offer is well invested to support further market share growth and benefit from any positive changes in the macro environment. Day-to-day, this means continued tight cost control, balanced with appropriate investment in key capabilities to ensure that we build our core proposition throughout the cycle. This approach continues to drive competitive differentiation and last year, we retained our #1 position in London property listings. We've continued to benefit from the investments we made during the last 2 years in people, technology and brand. And it's worth noting that those significant investments, which have improved our business, were made during a period of strong cost control. Since 2016, we've taken GBP 15 million cost out of the business, including a further GBP 3 million in savings last year. And that leaves us with a cost base, which is now GBP 7 million lower than it was in 2016. We'll continue to selectively invest in the business in this way. And we certainly start this year with a highly engaged fully staffed team who are ready to take advantage of any better conditions should they materialize. Now Slide 5 and some thoughts on lettings. The London lettings market remains an attractive and valuable sector for us despite the changes made to landlord stamp duty, mortgage tax relief and significant increases in legal and regulatory risks and costs since 2016, which have deterred new investment from private landlords somewhat. But although increasing regulation and legislation does require us to invest in our operations, we're relatively supportive of these developments as we believe that, in the long term, they'll increase standards in the sector and represents an opportunity for high-quality agents like Foxtons, who have the capabilities to protect the interest in landlords and tenants in more complicated and riskier compliance environment, to grow their businesses and win market share. The shorter-term impact of those changes is less positive, with lower levels of investment from private landlords, resulting in falling stock levels and higher rents for tenants. The 2 graphs on Slide 5 clearly show the recent impact of tighter regulation and tax policy on lettings in London, with 2019 stock levels falling each year since 2017. In fact, during 2019, stock levels in lettings were some 22% below those we saw in 2017. The impact on tenants has been higher rents, which, today, are approximately 7% or 8% above where they were at the beginning of 2017. We've now seen 7 months of the tenant fee ban in operation. And although it's too early to assess the long-term impact on the market, we are seeing competitors increasing landlord fees in an attempt to recover lost revenues from tenants. And we believe this makes our high-quality service even better value for money. Our successful development of a range of products and services for the institutional PRS rental sector has enabled us to double revenues from this segment last year. We're seeing really good benefit from the close relationships we have with many of the key players in that space and we're optimistic of being able to grow this new element of our business into a significant revenue stream over time. Turning to sales on Page 6. Although today, it does feel like we are somewhat at a turning point for the property sales market following the greater certainty from the outcome of the General Election in December, the sales market did remain very subdued throughout the whole of last year. Sales volumes in London fell for the fifth year running during 2019. Latest Land Registry data shows a reduction of 11% during the first 9 months of the year, and we estimate that volumes in London across the entire year will be on a par with those that we saw immediately following the credit crunch in 2009. And as I said, against that market backdrop, I believe our 4% decline in sales volume will represent strong market share growth once Land Registry data for the full year is available. And that result will be particularly pleasing given that we maintained our average fee of 2.4%, which is a significant premium to the market average and demonstrates just how much value there is in our differentiated business model and our brand. Market prices fell only slightly within London, with a relatively significant increase we saw in the proportion of lower value Help to Buy purchase in the sales mix when the average sales revenues fell by 6%. Looking forward, as I mentioned earlier, we've seen good improvements in a number of our demand side lead indicators, and we enter 2020 with a sales pipeline well above where it was this time last year and with lots of new, more confident buyers to work with. Overall stock levels, which started the year well down in the market, have started to respond, but today remains slightly down on last year. So it might be some time before our new buyers are able to transact and before we see increased activity flow through to revenues. There's still much uncertainty, of course, about where Brexit will take us over the remainder of the year, and the issues around affordability and stamp duty that created drag on the property market for some time still remain. However, during the first 2 months of the year, we have seen evidence of improving sentiment upon buyers and sellers, and this greater positivity is starting to translate into meaningful action, which is great motivation for our people. I'll come back shortly to talk about strategy. But let me now hand over to Richard for a closer look at our financials.

Thanks, Nic, and good morning, everyone. I'll take you through the financial review of 2019, and I'll start with the income statement on Slide 8. Total revenue in the year declined by 4% or GBP 4.6 million across the group, and I'll talk more about the component parts in a moment. We were able to offset GBP 3 million of the revenue decline through ongoing cost management, including branch closures made at the end of 2018 and other structural changes. In addition, we made a small reduction in discretionary spending to protect profitability. As a result, adjusted EBITDA was down by GBP 1.1 million to GBP 2.5 million. Ex IFRS 16, EBITDA was GBP 13.4 million, the difference being the removal of the lease rental payments. Adjusted items in the year totaled GBP 5.7 million, GBP 2.4 million with an impairment relating to the 4 branch closures at the end of 2019, GBP 1.3 million of branch costs and severance costs on those closures and GBP 1.9 million of other branch impairments. Taking those factors into consideration, the loss before tax in the year was GBP 8.8 million. On Slide 9, under lettings. As Nic mentioned, we had a solid year in lettings as the growth in volumes and underlying revenue from landlords largely offset the impact of the tenant fee ban. The impact of the ban was GBP 2.7 million in the 7 months from the 1st of June. Underlying revenue from landlords increased by GBP 1.4 million or 2%, and that was down to a number of factors. We grew volumes by 1%. We increased the penetration of property management from 33% to 34% and continue to go from strength to strength on institutional PRS. Contribution margin remained strong at 71%. Slide 10 on sales. So market volumes continued to decline in London in 2019, down to around 80,000, we estimate, the lowest since 2009. In that context, we were pleased to grow market share over the first 9 months of the year, we have data for. Foxtons' volumes were down 4% in 2019. Two other market-driven factors impacted performance, lower average selling prices, market prices were flat to slightly down in the year and is a slower market in the higher-price bans and a higher proportion of property sold under Help to Buy. Total revenue was down 10% in sales. On Slide 11 for mortgage broking. So Alexander Hall, our mortgage brokers, it was also a pleasing performance in the context of a difficult market backdrop. I think we worked hard to increase total volumes up 3%, with remortgages more than offsetting the decline from new mortgages. It was also pleasing to see that the average fee remained robust in this context. As a result, revenue was up 2%, and contribution margin was very healthy. The continued high level of service that our customers and clients get from Alexander Hall can be seen in both the customer and industry recognition they receive. On Slide 12, on operating costs. I thought it was worthwhile reflecting on how the business has managed the cost base since the sales market in London started to decline in 2016. A total of GBP 15 million has been saved in the last 4 years, and this has been important because it allowed us to protect profitability as much as possible when faced with the decline in sales volumes and cost pressure. This also allowed us to continue to invest in the areas of service that are important to our customers. In 2019, the gross savings made were GBP 4 million, and this was partially offset by inflation and investment of GBP 1 million. A further GBP 2.5 million of savings are planned for 2020, partly driven by the 4 branch closures that we announced in the final quarter of the year. In each case, we felt our customers could be as well served by other branches in the Foxtons network. The GBP 2.5 million savings expected in 2020 will offset cost inflation and discretionary investment. So costs will be broadly neutral, assuming volumes remain the same. Turning to the balance sheet on Slide 13. Three things I wanted to point out. So firstly, the cash balance remains strong at GBP 15.5 million. We have got a revolving credit facility for GBP 5 million, but that was undrawn through the period. The implementation of IFRS 16 increased the value of property, plant and equipment through the right-of-use asset. And at the same time, we introduced lease liabilities of GBP 55.9 million at the end of December. One final point is that we reviewed the implementation of IFRS 15 revenue in the lettings business in the period. There was no material change to the income statement in 2018 or 2019 as a result of this. But there is a small restatement of the 2018 balance sheet. As part of this, we established a contract asset and a contract liability, the latter of which replaces the refund provision we had previously. On cash flow on Slide 14. Key point to note is that, overall, the business has limited cash requirements at a relative low point in the residential sales market cycle. We continue to manage cash tightly, and this allows us to prioritize investment in our offering for customers. The key outflows that make up the GBP 2.4 million reduction in cash in the period were as follows: So working capital outflow of GBP 1.9 million. This relates to two things: Firstly, a short-term trial promotion in the lettings business that we allowed our customers to defer commission if we -- if they took their property management offering; and secondly, the strong performance towards the end of the year, for which cash had not been received at year-end. Adjusted items spend of GBP 1.1 million related to the branch closures in both 2018 and 2019. We've had good success in reducing the liabilities on vacant property, but some still remain. Capital expenditure has remained under tight control at GBP 0.5 million in the year. On Slide 15, turning to the financial guidance for 2020. So in the year ahead, we continue to run the business much the same way as we have over recent years. The tenant fee ban impact lettings revenue in the year by GBP 1.7 million in the first half. Added to the GBP 2.7 million impact in 2019, this takes the total annualized impact to GBP 4.4 million. Cash operating expenses, including rentals, are expected to be broadly flat, excluding any changes in volumes. Within this, total savings of GBP 2.5 million are broadly expected to offset investment and inflation. The cash savings will be evenly spread through first half and second half of the year. However, the inflation and investment are biased towards the first half of 2020. Depreciation and amortization are expected to total around GBP 13.5 million, and CapEx will continue to be tightly managed. It might increase slightly in the year, but it will still remain below GBP 1 million spend. The cash spend relating to the historical branch closures is expected to total GBP 1 million in 2020. And we expect to spend between GBP 3 million and GBP 4 million on acquiring high-quality lettings books, which Nic will discuss shortly. Having historically used EBITDA as our key performance measure, we're going to introduce adjusted operating profit as an alternative in 2020. Post the implementation of IFRS 16, EBITDA ceases to be a great measure of our performance because it excludes one of our largest cost areas being lease rentals. It's also less useful as a proxy for cash generation. We think it's, therefore, more appropriate to introduce adjusted operating profit, and details on how this is calculated and what the historical comparisons are can be seen in the appendix. On the cash side, net free cash flow remains our priority, and it will be the main measure we focus on going forward. On Slide 16, we have the financial summary. I won't go through the whole slide, but the key points to note are the ongoing cost management has helped to largely offset the decline in revenues in 2019. Growing the lettings business remains a key strategic priority for us because of the cyclical protection it provides to unset against the volatility of London sales market. We continue to manage the sales business -- we continue to manage the business tightly, but have also protected investment in the infrastructure. That, combined with our high levels of operating leverage, ensures that we will be well placed to capitalize on any recovery in the sales market in 2020. I'll now hand back to Nic for the strategy update and outlook.

Thank you, Richard. Turning now to Slides 18 and 19, I'd like to bring together some of the strategic themes and competitive differentiators we've been highlighting during the results so far and walk you through some of the key outcomes we've delivered last year against our priorities. Our key objective as a business is to deliver exceptional service to support our premium position in the London property market, which we still see as highly valuable despite recent headwinds. And we create competitive advantage from five key areas of our business, each of which deliver real value to our customer base. First, we have the leading brand in the sector, synonymous with delivering positive results for customers. Our high level of brand awareness was initially created by our network of highly recognized branches and our minis. And now, we support that awareness through sophisticated digital brand marketing, too. Secondly, we believe a state agency is fundamentally a people business. We know that our customers want to deal with knowledgeable, experienced and hard-working people who go the extra mile. And our culture nurtures and rewards these values and behaviors and creates powerful relationships with customers for the long term. Technology remains a key differentiator at Foxtons. The business is underpinned by a content-rich bespoke in-house operating system, which offers a simple single digital platform for managing customer data and workflow. And our MyFoxtons web portal continues to be extremely popular with our customers, offering 24/7 service for landlord, sellers, tenants and buyers. The group's unique centralized business model creates sales efficiency, productivity and scalability, which results in significant operational leverage. It also enables us to centralize support functions and databases that gives us a single view of customers, enabling us to deliver seamless integrated services to them. Together, these differentiators are designed to create a balanced business, with sales and lettings providing equal contribution through long-run property cycles. Slide 19 outlines some of the progress we've made on some of these strategic priorities last year. In terms of single brand, we remain the most well-known brand in the state agency in London, with the results of a recent YouGov survey indicating our brand has over 3x the awareness of our next closest competitor. This strong brand awareness supports our #1 position in listings across London property. And alongside our innovative and highly targeted digital marketing strategy, it's enabled us to significantly improve marketing effectiveness and drive down customer acquisition costs and also to increase market share, all of this despite lower levels of customer activity and fierce competition last year. Our digital marketing strategy has been particularly effective. Digital inquiries last year were up 9% overall, whilst the average cost fell 24%, and our conversion of web valuations to instructions increased 19%, thanks to our rigorous web marketing optimization programs. The resilience commitment and enthusiasm of our people never ceases to impress me. And last year, despite difficult marketing conditions and the cost actions we took in response to them, we achieved good volume productivity growth and stable revenue per head, which was particularly impressive in light of the tenant fee ban in lettings and the year-on-year decline in sales, volumes and values in London. Overall, our employee engagement remains extremely high, and that's a great testament to the quality of our management team. As I mentioned before, our data and tech are key competitive advantages of Foxtons. No other estate agency portal offers the same level of features and functionalities found in MyFoxtons, and it remains a core component of our ability to support a great customer experience. There are currently almost 800,000 MyFoxtons accounts with over 17,500 tenants and 8,000 landlords logging on each month to manage their transactions and their tenancies. And this gives us a unique channel for communicating in ways which are most convenient for our clients. In 2019, we further enhanced the property management functionality for landlords and tenants on the portal by introducing an automated tenant deposit release solution, which is a market-first in the U.K. It helps address a key pain point in the lettings process and helps to improve the penetration of our managed services. Finally, we've successfully used our tech and centralized business model and digital marketing to expand the reach of our branches, and this allowed us to shut with conviction the 4 underperforming branches that we did in the year, whilst remaining and retaining the ability to serve the same territories from adjacent branches. The high levels of service we provide and our customers' loyalty substantiated by our continued excellent rating on Trustpilot as well as by increases last year in landlord retention and tenant renewal rates. Our business centralization and dedicated support functions helped us deliver improving average revenue per branch and productivity last year, and we also improved cross-sell across the group, growing revenues in both mortgage broking and conveyancing. As Richard mentioned a moment ago, we've begun to look more seriously this year at lettings book acquisitions. We've looked at a number of businesses over the last 6 months, and we'll be making the first of what I hope will be several acquisitions this year next week. We've been very selective in our approach to date, concentrating on businesses that have been well-run with strong local presence, fee, integrity and high levels of high-quality regulatory compliance. Let me finish on Slide 20 by summarizing where we are now with a few further comments on outlook. The strength of our highly differentiated business model, brand and clear service proposition supports a compelling offer that is relevant today as it ever has been. We continue to deliver exceptional results for our clients, and that differentiates us from our competitors and creates a firm platform for future growth. The combination of our highly motivated and experienced agents, our market-leading tech and our network of interconnected branches enables us to deliver the premium, high-touch service that the Foxtons brand is synonymous with. Our cost management program and the strength of our balance sheet has enabled us to deal with market conditions over the last 5 years whilst continuing to selectively invest in our core capabilities to strengthen our business for the long term. Finally, on outlook. Whilst there are still challenges in the core markets that we serve, we begin 2020 with a positive outlook, a motivated and fully resourced team and good momentum building in our sales pipeline. Given the timing of those improvements, I wouldn't expect, however, to see significant impact on revenues until Q2. We are pleased with our progress in lettings, and this continues to be a priority for the business. We expect our ongoing commitment to landlords in light of the tenant fee ban to further improve our proposition, and we're confident that this will continue to drive market share growth. The tight lettings market does make organic growth more difficult. And as a result, as I mentioned a moment ago, we intend to become more active in acquiring lettings books over the coming year. And as I said, we'll be announcing our first of these early next week. And that's all I wanted to cover as part of the formal presentation, but we'll be very happy to take any questions from people on the call now.

[Operator Instructions] We'll now take our first question over the phone from Sam Cullen from Berenberg.

I've got a few questions. Firstly, on the average fee in sales, it looks to have come down by 10 basis points or so. Can you just talk us through that? Is that kind of -- is that mix? Or is that any kind of headline fee reduction? Second question relates to kind of PRS and build-to-rent, just kind of broader question, I guess, really. Can you just talk us through that opportunity a bit more where you see it kind of developing over the next couple of years? And then just lastly and kind of clearly not -- relating directly to the one you expect to announce next week, maybe you could just talk us through the economics for lettings book acquisitions. That would be helpful.

Perhaps I'd take some of those, and if Richard or Patrick wants to chip in, then feel free. On the average fee, our average sales commission is pretty consistent at 2.4%, which is flat on last year. As I mentioned, the overall average revenue for sales has been impacted by just mix, and that's really because we've had quite a lot of success in Help to Buy new homes last year with, obviously, the average property sales within London being slightly higher than those typically. So that's a mix issue, really. In terms of PRS, our initial sort of foray into this sector has been very much working with the large institutional investors, making sure that we get good quality tenants and lease up their buildings quickly. And we're looking, at the moment, having a bit of a strategic review of that business, to see whether there are greater opportunities to move up the value chain in terms of giving advice to those organizations. As you know, we have huge amount of data on the lettings market in London going back over 20 years. And the companies that we're working with find that data very useful in their ability to understand where to invest and how to invest in the sorts of property and tenant preferences that exist in the marketplace today. So we think there's an opportunity to move, as I said, up the value chain there and create a bigger business there. In terms of the acquisitions, the one we're announcing next week will be relatively significant in the context of Foxtons, although it won't be huge. We expect, as Richard said, I think, to spend around GBP 3 million to GBP 4 million. The drivers for that, really, as I said, first of all, organic growth, we think, will be under pressure in lettings going forward because of the exit from private landlords from the marketplace. And so organic growth will be more challenging. Having said that, the removal of the tenant fee has meant that some of these lettings books, I think, will be available at more realistic multiples. And because we've got such a large-scale lettings business within Foxtons and with the changes and developments we've made in the business over the last couple of years, it means that there's a huge ability to get some synergies from those businesses as we bring them into the Foxtons portfolio. And that's not only -- and will not even primarily be cost reductions, but will be all around giving better quality service to landlords coming into Foxtons, through our portal, through our dedicated property management capabilities and also in ensuring that their properties are rented at good values. So that's really the driver there. And as I said, we're taking a sort of prudent look at these books. We're only looking at books which have good regulatory compliance, high quality people, high quality tenancies. Richard, do you want to add anything to that?

Yes, just on the financials, Sam. So the multiples at the moment, the ones that we're seeing recently, and over to 1.5x to 2x revenue as a purchase price, our contribution in lettings is around 70%, and we'd look to be able to generate that from new acquisitions. The key driver of success is the level of landlord churn that you get post acquisition. They work relatively well from our perspective, up to a churn of 10% per annum, and they kind of broadly break even at about 15% per annum. Obviously, we'd like to do better than both of those positions to maintain as much -- maintain those landlords as much as possible. And broadly, targeting the payback in 3, 3.5 years.

[Operator Instructions] We'll now take our next question from Chris Millington from Numis.