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If It Ain't Broke, Don't Fix It

Posted by Ryan Irvin

on Monday, 16 April 2018 11:22

This month I update two long-time favourite stocks from our Canadian Growth Stock Research -  Boyd Group Income Fund (BYD.UN:TSX) and Enghouse Systems Limited (ENGH:TSX). Both have been long-term winners in our Focus BUY Portfolio and both were recently upgraded once again to BUYs.

The first and best performing is Boyd which was originally recommended in November 2008, when the Fund’s units traded at $2.30. Recently, with the stock trading above $100.00 we update our ratings and take a look at the company’s recent results and outlook moving forward.

First off, what does Boyd do? The business is simple, Boyd is one of the largest operators of non-franchised collision repair centres in North America. The company currently operates locations in five Canadian provinces under the trade names Boyd Autobody & Glass and Assured Automotive, as well as in 22 U.S. states under the trade name Gerber Collision & Glass. Boyd uses newly acquired brand names during a transition period until acquired locations have been rebranded. The company is also a major retail auto glass operator in the U.S. with locations across 31 U.S. states under the trade names Gerber Collision & Glass, Glass America, Auto Glass Services, Auto Glass Authority and Autoglassonly.com. Boyd also operates Gerber National Claims Services (GNCS), which offers glass, emergency roadside and first notice of loss services with approximately 5,500 affiliated glass provider locations and approximately 4,600 affiliated emergency roadside services providers throughout the U.S.

2017 HIGHLIGHTS

×         Revenues increased by 13.1% to $1.6 billion from $1.4 billion in 2016, including same-store sales increases of 1.0%. After adjusting for one less selling/production day, same-store sales increased 1.4% on a per day basis.

×         Adjusted EBITDA increased 17.2% to $145.6 million from $124.3 million in 2016, representing approximately a 0.30% or 30 basis point improvement in adjusted EBITDA margin.

×         Adjusted net earnings increased 11.8% to $58.8 million compared with $52.6 million in 2016 and adjusted net earnings per unit increased 9.0% to $3.182 compared with $2.920 in 2016.

×         Added 105 locations, including the strategic acquisition of Assured Automotive, which represented 26% growth in new locations.

VALUATION

Boyd is certainly not cheap trading in the range of 32 times trailing earnings over the last 12 months. The company deserves a premium to its peers given its strong long-term track record of growth and the continued growth path ahead for the business. Boyd is expected to grow adjusted earnings by approximately 35% in 2018 and another 29% in 2019 giving it a forward PE of 23.17 based on 2018e earnings and 18 times 2019e earnings. In our last update, we concluded that the company had between 10-15% upside over the next year. Given the projected uptick in 2018 same-store sales growth, the robust acquisition market and strong projected earnings growth, we now forecast the shares have the potential to gain approximately 20-25% over the next 12-18 months. This would be based on an increased multiple of 13.25 times expected 2019 EBITDA.

CONCLUSION

2017 was a challenging year for Boyd as the company faced significant headwinds including mild and dry winter weather followed by business interruption from severe summer hurricane storms, an unfavourable currency environment and an ongoing technician shortage, which particularly impacted same-store sales growth in the fourth quarter. Despite this, the company executed well on its stated goals, achieving record levels of revenue and adjusted EBITDA and growing to over 500 locations.

Management reiterated its confidence in the 2020 growth target to double the business from the 2015 level. The technician shortage Boyd faces and forex will continue to be headwinds in the near term, but with the acquisition front positive and same-store sales expected to rebound, the outlook is decidedly positive near and long term.

Boyd continues to execute on its growth strategy. During 2017, the company added 37 locations in addition to the 68 locations added as part of the Assured acquisition, for a total of 105 locations added, representing new location growth of 26% for the year, while at the same time achieving organic growth through same-store sales increases of 1.0%, adjusted to 1.4% on a per day basis.

Looking forward, management will continue to pursue accretive growth through a combination of organic growth (same-store sales growth) as well as acquisitions and new store development. Acquisitions will include both single location as well as multi-location. With prudent financial management and its strong balance sheet, Boyd is well-positioned to take advantage of large acquisition opportunities, should they arise, which could accelerate the time frame to double its size. It is expected that this growth can be achieved while continuing to be disciplined and selective in the identification and assessment of all acquisition opportunities.

We expect Boyd will continue to face headwinds from the lower value of the U.S. dollar relative to the Canadian dollar in comparison to Q1 2017, but the long-term growth prospects remain strong. The company’s shares have been volatile of late trading as high as just under $112 and closing today at just over $100. We expect this to continue in a jittery market, but Boyd is a company we have mid-term confidence in and would look to add on pull-backs for the long term. On any further price surges, the company could potentially use its premium share price to raise a bit of capital and pay down debt. Given the strong earnings growth projected in both 2018 and 2019, we are once again comfortable buying Boyd in the near term and upgrade our rating to BUY (Half Position) for new clients. Again, our long-term rating remains at BUY with the stock in our Focus BUY Portfolio for those clients looking to hold for between 2-4 years.

EXCERPT FROM RECENT UPDATE

Enghouse was recommended in February of 2011, with the company’s shares trading at $8.35. In our most recent upgrade update, with the company’s shares trading in the $53-$59 range, we ranked the stock as a HOLD in the near term and advised new clients buy HALF POSITION with a 3 to 5-year time horizon. For a good part of the last 8 years, Enghouse has been a company we would not hesitate to buy on dips as it is cashed-up, produces very strong cash flow, is a dividend grower and is very prudently managed. After a somewhat challenging year for its Interactive Management business, the company recently released solid fiscal 2017 annual results.

OPERATIONAL SUMMERY

Enghouse develops enterprise so ware solutions for a number of vertical markets.  e company separates its operations into two business segments: The Interactive Management Group and the Asset Management Group. The Interactive Management Group specializes in customer interaction so ware and services that are designed to enhance customer service, increase efficiency and manage customer communications across the enterprise. Core technologies include contact center, attendant console, interactive voice response, dialers, agent performance optimization and analytics that support any telephony environment, deployed on-premise or in the cloud. Its customers include insurance companies, banks and utilities as well as high technology, health care and hospitality companies. The Asset Management Group provides a portfolio of products to telecom service providers, utilities and the oil and gas industry. Its products include Operations Support Systems (OSS), Business Support Systems (BSS), Mobile Value Added Services (VAS) solutions as well as data conversion services. e Asset Management Group also provides fleet routing, dispatch, scheduling, communications and emergency control center solutions for the transportation, first responders, distribution and security sectors.

5G – LONG TERM BUT GRADUAL GROWTH DRIVER

From information provided by telco equipment vendors, carriers, and other public companies attached to the Communications segment, trials with commercial-grade equipment for 5G or 5th Generation Wireless will start later this year. At the end of 2017, the wireless industry came up with the first official 5G standard. AT&T plans to launch mobile 5G in the U.S. by the end of 2018 and Verizon reported it will launch 5G for homes, and T-Mobile is working on a network to launch in 2019. Many industry experts expect the first 5G mobile devices to launch in the first half of 2019, based on timelines from Qualcomm. This all lines up with initial goals of having commercial 5G deployments by 2020. Standards development and product commercialization have accelerated.

Enghouse is likely to have solid exposure to the 5G upgrade cycle.  e company could play a significant role in helping carriers revamp legacy systems and migrate to newer technologies. Given this backdrop, there could be additional growth upside in the company’s networks business. The company has stated they see a healthy M&A pipeline related to 5G and there is an expectation for a long 5G investment cycle.

CONCLUSION

Once again, we were pleased with Enghouse’s Q1 2018 results which beat estimates on an adjusted EBITDA basis. While revenue growth has slowed, hampered by a relatively sluggish telecom segment, the company continues to build cash and grow EBITDA. Revenue of $85.1 million was slightly higher than the consensus in the $84 million range – Forex rate movements affected revenue positively by approximately $700,000. The very strong EBITDA margin of 29.8% drove EBITDA of $25.3 million, which beat consensus of $23.3 million to $23.4 million. Of note, earnings and EPS were affected by one-time items related to the U.S. tax reform. The charges include: 1) a revaluation of deferred tax assets and liabilities and 2) a repatriation tax of $8.8 million. The thought is that Enghouse’s effective tax rate will fall if the U.S. federal corporate income tax rate drops to 21% from 35%.

The company has been a model of consistency paying regular quarterly dividends since May 31, 2007.  The company’s Board of Directors approved another increase to the company’s eligible quarterly dividend to $0.18 per common share, payable on May 31, 2018, to shareholders of record at the close of business on May 17, 2018. Enghouse has now increased its dividend in each of the past ten years by over 10% each year.

The core story with Enghouse, as it has been since day one, is the strong free cash flow generation and growth via smart accretive acquisitions. Cash on hand at the end Q1 2018 was $145.0, or $5.28 per share. Enghouse still sees an active pipeline of opportunities, and attractive pricing its target range. With the appointment of New President, Vince Mifsud, and his stated goal to revamp the sales organization, we expect a longer-term focus on stronger organic growth. Mifsud will focus on demand generation and creation of a sales team that will have more of a direct sales effort as well as stronger channel partner support. The new CEO believes there are significant opportunities to accelerate organic growth considering Enghouse’s products are well-regarded. These changes to the sales organization are not expected to materially impact margins. At present, most analysts expect acquisitions to have a higher impact on margins than organizational changes.

At first glance, with a price-to-earnings of 36, Enghouse appears expensive. Indeed, with the share price up over 600% since our original recommendation, the stock is not cheap. The multiple expansions we have seen has been due to consistent growth (proven track record from management) and has been assisted by a solid overall tech market – or lack of good alternative tech stocks in Canada. When we dig a little deeper we find that the company’s consensus 2019 adjusted EBITDA estimate is in the range of $3.96. If we strip out the $5.28 per share in cash and just look at the base business, the forward looking EV/EBITDA is a more reasonable 15.48.  is multiple is slightly below Enghouse’s peer group.

The market has now caught-up to the Enghouse story and is willing to pay a premium for the strong free cash flow and earnings power going forward. In the $75 plus range in 2015-2016, Enghouse got ahead of itself, but the combination of strong management, a pristine balance sheet and above average growth potential continues to position the company to be the market average return looking 3-5 years.

As such, we upgrade our near-term rating from HOLD to BUY (HALF POSITION) for new clients and maintain our long-term rating at BUY (HALF POSITION). Given management’s track record, we believe the company will outperform the market over the next 3 to 5-years. Enghouse remains on our Focus BUY list.


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