The stock market loves companies that have been sailing through the pandemic with strong business activity and robust profits. Toronto-based FirstService Corp. has joined this elite group, but does the stock’s recent rally have staying power?
The real estate services company operates two businesses that largely operate in the United States, which explains why the stock trades on the Nasdaq as well as the Toronto Stock Exchange.
FirstService Residential provides property management services to residential communities, such as condominiums. FirstService Brands consists of businesses that do painting, carpeting and other restoration work, under brands such as California Closets and CertaPro Painters.
The company’s focus on real estate at first unnerved investors during the initial lockdown earlier this year. The stock slumped about 34 per cent in February and March, a selloff that was in line with the broader stock market as investors panicked over the prospect of a buckling economy and lost revenue.
But the decline didn’t stick. Since hitting a low in March, the stock has rebounded more than 80 per cent.
In July, the share price eclipsed its prepandemic high. The price is now more than 20 per cent higher than it was in mid-February, before the lockdown – a feat that stands out even within the tech-heavy Nasdaq, which is 12 per cent above its prepandemic high.
The reasons behind its standout performance? Residential real estate has been remarkably resilient during the pandemic and economic downturn, feeding demand for the company’s services. U.S. existing home sales in September increased 21 per cent, year-over-year, as low mortgage rates drove resale activity across the United States.
“At a time when most sectors of the economy continue to struggle under the weight of the pandemic, the housing market remains a bright spot,” Admir Kolaj, an economist at Toronto-Dominion Bank, said in a recent note.
But FirstService is also getting more business because of unsettled weather, which has driven demand for housing repairs. Frederic Bastien, an analyst at Raymond James, noted that Hurricane Laura, the devastating Category 4 hurricane that walloped Louisiana and Texas in August, and the Iowa windstorms that same month delivered US$45-million in incremental business.
Third-quarter financial results, released last week, reflected the fact that FirstService appears to be navigating the pandemic well.
Revenue increased 10 per cent, year-over-year, while EBITDA (or earnings before interest, taxes, depreciation and amortization) increased 15 per cent. The company’s profit margin (using EBITDA) was 12 per cent, exceeding analysts' expectations.
FirstService, already one of the largest full-service managers of residential properties in North America, spent US$64-million on acquisitions in the third quarter alone. Yet, its debt profile actually improved: The net debt-to-EBITDA ratio declined to 1.7 from 3.2 a year ago.
“Its liquidity [or available cash to deploy] remains largely unchanged, at US$575-million, yielding management the flexibility to go after acquisition targets of all sizes,” Mr. Bastien said in a note.
But investors are now being asked to pay a lot for this pandemic success story. After the stock’s recent gains, its price-to-earnings ratio is now about 35 times analysts' estimates of 2021 profits – making the stock an expensive bet on real estate services at a time of tremendous economic uncertainty because of rising COVID-19 infections.
The bullish case is that this uncertainty is exactly why the stock should command a premium valuation: The company has shown it can thrive in today’s turbulent environment, raising the stock’s appeal.
But the high valuation suggests that a lot of expectations are now built in. FirstService has thrived this year amid a difficult economic backdrop. For investors who want a piece of the action, though, the lofty share price is now arguably the bigger challenge.
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