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Staying afloat

publication date: Jan 2, 2012
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Estate agency shares haven’t, perhaps, been the best stock market investment you could have made back in 2006 or 2007. Most of them, though they’ve bounced back to some extent, are still trading at much lower levels than they were then; and some have disappeared (Humberts for instance went into administration in 2008, and
the business was then bought by Mercantile Group.)

But most have also made substantial progress over the past few years in cutting costs and putting their houses in order – and several are even managing to expand.

Savills for instance has recently increased its American representation, opening new offices in Washington and Los Angeles, and is continuing to diversify by establishing new lines of business. Its consultancy business saw profits cut nearly a third, as the firm invested in building new teams and opening new offices. Though it made a loss in 2008, it has come back strongly since; last year saw the company nearly double earnings per share – the main figure that investors look at.

Interim results saw Savills increasing its revenues by ten per cent, with pre-tax profit up nearly 40 per cent. That reflects a strong performance in Asia, particularly Vietnam, as well as strength in prime London property, with overseas investors flocking to the UK. Internationally represented agents like Savills are particularly well placed to win that kind of business.

While Savills is a multidisciplinary firm, it was the residential business that contributed most of its growth. Commercial property saw profits fall, while UK residential saw revenues up 22 per cent and profits up 50 per cent, and Asian residential did even better. Fund management and property management activities also saw good performance, reflecting the firm’s prudent decision to diversify its sources of income.

Share prices dip… and crash
But Savills’ shares are quoted on an earnings multiple of only 10.8 times, and offer a yield of 3.1 per cent. That makes it cheaper than Tesco, Royal Dutch Shell, or Vodafone – at least on an earnings basis (all three of the other stocks pay higher dividends). The shares are now trading close to a 52-week low after hitting highs
in June this year.

One reason for this is that analysts expect Savills’ earnings to take a dip this year. The company has warned that Asia is likely to see some deceleration as governments – particularly in China – move to defuse inflation. Andrew Cox, an analyst at Numis Securities, says the cautious tone has affected investors’ sentiment – and the continuing European crisis hasn’t helped.

Still, Savills looks the best placed of the multidisciplinary firms. DTZ on the other hand saw CEO Paul Idzik walk out together with his finance director earlier this year, and could be vulnerable to a bid from majority shareholder SGP.

It’s a pity, because Idzik’s medicine had worked; in three years, he had reduced costs by 26 per cent, with a strong focus on productivity. Just last year, he managed to get operating costs down from 30 per cent to 29.6 per cent of revenues. While the company was still making losses, those losses had been greatly reduced. 

Investment in Asia was also bearing fruit; like Savills, DTZ saw strong growth there, as though China had begun to slow, South East Asia and India performed well. Investment and asset management revenues grew strongly in financial 2011 too, showing 19 per cent growth and a £1.3 bn increase in assets under management.

Sir John Titblat, chairman, Colliers However, DTZ still had £64m net debt, and Idzik said that meant the company couldn’t invest as aggressively as he would have liked. This may be one reason for his resignation alongside ructions with the majority shareholders’ representatives on the board. More recently we’ve heard in a trading statement that DTZ had “a challenging start to the trading year”, and despite hopes of a bid, the shares have slumped and it is still for sale.

Colliers International has also seen its share price crash their year, from nearly 20p to just over 6p. Colliers has made losses in all the past three years, and is expected to make a loss this year too. However, revenues are now growing for the first time in years; the losses are down to a planned recruitment programme.

Sir John Ritblat (left), Chairman, says in the annual report that the company has seen a “transformation in activity in the past year”, but admits it has been “patchy”. Revenues at £65m last year were not much more than half the £117m achieved in 2007, and with 2.5 per cent growth expected this chairmanyear, Colliers is not going to make up the gap quickly.

Meanwhile Fletcher King looks one of the cheapest stocks on the market, sitting on a yield of over five per cent and with a historic price/earnings multiple of less than eight. That seems churlish for a company that saw revenues last year increase 14 per cent, and profits soar from £288,000 to £414,000, particularly when it also resumed dividend payments.

But the City analysts are looking ahead, and obviously don’t like what they see. Though the current year started with a good level of sales instructions, the company’s management has warned that it will be difficult to match the previous financial year’s performance. David Fletcher, Chairman, says the majority of instructions fall into the “difficult to sell” sector, and refers to the year ahead as “challenging”.

Stingy ratings
The pure residential agencies have also seen their share prices slump over the summer. For instance LSL, owner of Your Move and Reeds Rains, saw its share price fall from nearly £3 to under £2 in a couple of months this summer. That leaves it trading at under 10 times earnings, with a yield of four per cent – again towards the cheaper end of the market.

Yet for the last couple of years, it’s had rather good results, after a shock loss-making result in 2008. Results for 2010 saw pretax profit double, with agency revenues up 15 per cent on a like-for-like basis, though by the interim stage this year that had slowed to seven per cent growth. LSL has also been growing its market share.
A close look at the recent interim results, though, shows some weaknesses – not just the deceleration of revenue growth. Operating margins were down, at 11.5 per cent of revenues, suggesting that efficiency gains may be at an end. And while the agency business saw a seven per cent increase in volume, it was financial services and lettings that really delivered – up 42 per cent and 19 per cent respectively.

Still, the company is expected to increase earnings by eight per cent this year, so the rating looks stingy – as does that of M Winkworth plc, which trades on a price/earnings ratio of 11 and yields 5.1 per cent. Earnings are only expected to grow at seven per cent this year, and could be flattish in 2012, but even so, the rating seems churlish given Winkworth’s success in growing its business in recent years.

One reason may be that 2011 is unlikely to be a vintage year. In 2010 Winkworth saw transactions increase 22 per cent, and grew by adding new offices to the south and west of London, in Romsey, Bath, Exeter, and Newbury. It also opened a country house department to focus on higher value properties. But the second half of the year was more subdued than the first half, and deceleration seems to have continued this year.
The interim results for the six months to June 2011 showed sales up 6.5 per cent and profit flat, even though rentals (up 10 per cent) stood at a record level The company also generated less cash from operations, though that is partly explained by high investment in new offices.

Estate agency transactions were down, and Dominic Agace, the CEO, commented; “Low volumes are expected to continue, particularly outside London, and we expect this to lead to further branch closures by over-extended companies.” While that won’t help the figures in the short term, it gives Winkworth the opportunity to expand at the expense of weaker independents – the company has already increased its target for new offices this year from eight to 10, and it may even beat that revised figure.

Others are on the up
So much for the agencies – obviously the City isn’t happy with the way the economy is going, and is selling out in case the housing market tanks again. That’s not illogical – Alan Collett, Chairman of ARIM, says, “Estate agents have a high dependency on turnover, and turnover for these groups is going to be quite restricted for several more years.”

Rightmove hasn’t put a foot wrong despite demanding conditions; it has managed to increase earnings by a double figure percentage every year for the past five, and is expected to continue growing at 15 to 20 per cent. Perhaps it’s not surprising, then, that it trades on a dizzying 27.6 times earnings – way above any of the quoted agencies.

When you analyse the numbers, it’s obvious that Rightmove’s financial success doesn’t depend on the volume of house sales. The number of advertisers hasn’t changed much in the last eighteen months; instead, Rightmove has concentrated on increasing the amount each agent spends. In 2010, ARPA (average revenue per advertiser) increased from £308 to £379 a month, and in the first half of this year it increased again to £430, a growth rate of18 per cent year on year.

The relatively new display advertising product accounted for nearly half the total growth in Rightmove’s revenues. Even developers are spending more; average spend on new developments was up 13 per cent compared to a year ago, with the new development microsite product helping push up returns.

Add to that the fact that Rightmove has continued to increase its commanding market share – up one per cent to 83 per cent – as weaker portals drop out, and it’s easy to see how it has achieved growth despite a poor housing market.

Lessons learned?
So what can we learn by looking at the quoted sector? Well first of all, the fact that the market is still unsettled. The tone of all recent trading statements has been cautious; no-one is willing to call the turn in the market. It’s intriguing that Colliers ‘ fastest growing area in 2010 was Corporate Restructuring – working for lenders and insolvency practitioners in distress situations – which more than trebled its revenues. The City is wary of a double dip hitting the property market, and is keeping valuations low. Any agent wanting to raise funds is going to find life tough.

That’s possibly one reason many firms are focused on cash generation and debt reduction. For instance LSL reduced its debt pile from £20.8m to £4.9m in 2010, despite increasing the dividend by 56 per cent. Savills, too, has increased its net cash pile.

Yet alongside that it’s clear that many players are taking advantage of opportunities in the market to expand their market share. LSL says it increased its market share from 2.7 per cent in the second half of 2009 to 3.5 per cent on a like for like basis; it also added 1.2 per cent additional market share through the acquisition of Halifax Estate Agencies. That’s helped it maintain profitability even though the market has contracted by 63 per cent since 2007.

The independents are getting squeezed, which isn’t entirely a bad thing for the quoted sector. Winkworth has seen a huge increase in interest from independent estate agents wanting to convert to the Winkworth franchise – from just eight applicants in the first half of 2010 to 35 so far this year. There will probably be more infill acquisitions in the next year or so, too, like Savills’ purchase of property management firm Stadsmuren.

Alan Collett, RICS housing spokesmanAlan Collett, comments wryly that, “It’s always hard to acquire businesses when the market is booming. So the sensible business does try to acquire when the deals are available.” He advises other firms, “If you’ve got the cash then deploy it!”

Most of the more successful agents have diversified, too. LSL has been particularly successful with its ex-Halifax offices, which doubled their lettings revenues and quadrupled their finance sales between the first and final quarters of 2010 (LSL’s own businesses grew 12 per cent and 35 per cent). Fund management has been profitable for Savills, and many firms have seen good returns from property management activities.

But perhaps the most striking feature of recent results announcements has been the extent to which it’s central London which is driving the market in both commercial and residential property. “Prime London residential markets have been seen as a haven for the world’s investors,” according to Jeremy Helsby, group chief executive at Savills. David Fletcher, chairman of Fletcher King, refers to the market as “strongly polarised” between London and the provinces – while London is strong, “elsewhere in the country the market is very patchy,” he says.

Meanwhile Sir John Ritblat at Colliers quotes prime rents up by 28 per cent in the City and 10 per cent in the West End, with overseas investors seeing UK property as a “safe haven”. But, he says, the provinces are falling behind, as are secondary properties. Winkworth, too, is seeing profits growth driven by higher value properties. That suggests it’s only the most expensive ten per cent or so of the market that is selling – entry level properties are not.

That makes the market look very fragile. Smaller houses and flats in less desirable areas just aren’t moving; and outside the magic circle of London and a few spots in southern England, the market seems to be becalmed. There’s just a single bright patch in this market, on which all the quoted agents’ profits depend; and if anything happens to darken that one bright patch, there will be blood.

Do you have any views to share?