Foxtons Group — Medium-term targets come into view

At the beginning on 2023, CEO Guy Gittins set out a strategic vision to return Foxtons to its former position as London’s go-to estate agent. This included growing the non-cyclical and recurring revenues, which have grown to 72% for the group, to target operating profit of between £25m and £30m and to achieve an operating margin of over 15%. A lot of progress has been made in this direction, with unprecedented investment in staff training and retention, and also developing the proprietary IT systems that put Foxtons ahead of its competition.

Foxtons utilises its own bespoke operating platform that gives it an edge over the competition. It is a powerful and unique asset that facilitates expansion and industry consolidation over the longer term. The platform has unmatched technology and data capabilities that drive high levels of lead generation, deal excellence and lifetime customer value, while also creating high levels of scalability, all key to delivering growth and ensuring that Foxtons reaches its operating profit target in the shortest space of time.

In 2023, the Foxtons operating platform supported significant year-on-year market share growth across all three businesses, with the Lettings market share up 16%, Sales up 21% and Financial Services up 11%. Foxtons also reclaimed the number one estate agency position in London, is now the UK’s largest lettings estate agency brand and was the fastest growing large UK estate agency brand.

Exhibit 1 gives an overview of the five key elements of the Foxtons operating platform.

These five elements are explained in more detail below.

Foxtons FY23 results were affected by a range of issues, from strong Lettings rates and market share gains, to weak underlying sales markets and declining house prices. That said, management action to develop a stronger business supported by the Foxtons Operating Platform is paying dividends, which is evident in more motivated employees, reduced staff turnover and increased brand awareness. Overall, revenue and profits increased and although Foxtons ended the period with net debt, the cash-generative nature of the business is likely to see this return to net cash, which in turn is likely to be reinvested in further value-enhancing M&A.

Foxtons’ FY23 results came in modestly ahead of expectations, with revenue up 4.9% to £147.1m, largely driven by the strength of the Lettings division, offset by weakness in Sales and Financial Services. Total adjusted operating profit increased 2.5% to £14.3m, implying modest margin erosion, from 9.9% to 9.7%, at least in part due to the deliberate retention of skilled staff to ensure the business has the right calibre of personnel and capacity to grow when markets recover.

Adjusted PBT rose 2.9% to £12.4m, and EPS (excluding exceptionals) declined 3.8% to 2.9p. The dividend was flat at 0.9p/share, implying cover of more than three times, and net cash reduced from £12.0m to net debt of £6.8m, largely due to investment in working capital of £10.8m as shorter landlord billing terms were introduced to improve competitiveness, M&A spending of £13.9m, £2.7m of dividends paid and £1.1m of share buy backs.

Total Lettings revenue increased 16% to £101.2m (2022: £86.9m) on the back of a c 5% increase in the overall lettings book to c 28,100 tenancies. Revenue was boosted by a 24% increase in the average revenue per transaction to £5,234, offset by a 6% reduction in transactions to 19,334, reflecting longer average tenancy terms reducing renewal volumes.

Of the £14.3m increase in Lettings revenue, £6.3m was organic growth, £3.9m was acquired revenue and £4.1m was additional interest earned on client monies. The £6.3m of organic growth was driven by four factors:

The acquired revenue reflected an incremental five months of trading from the May 2022 acquisitions, 10 months of Atkinson McLeod and two months of Ludlow Thompson. The interest income reflects the higher interest rates on client monies held, which offsets the increased costs of managing clients’ money, and compliance costs.

The Lettings operating margin expanded by 480bp, from 20.7% to 25.5%, benefiting from the operating leverage of growth, notably from the additional £14.3m of revenue and £7.8m of operating profit.

The chart below clearly shows that although the number of lettings in H123 and H223 was broadly similar to 2019, the average revenue per rental has risen by roughly a half as overall rates are now higher, and the portfolio has an increased proportion of properties that are now managed, which delivers a higher fee.

Sales revenue decreased by 14% to £37.2m, curtailed by a 10.7% decline in transaction volumes to 2,872, and a 3.6% decline in the average revenue per transaction to £12,942. Although the volumes were down, according to industry data (source: TwentyCi), Foxtons materially outperformed the market, which declined 22% in volume terms. The decline in average revenue per transaction reflected a 1% fall in the average price of properties sold (2023: £586,000) and a small decline in average commission rates from 2.29% to 2.25%. London property prices fell 2.4% (source: Nationwide House Price Index) and therefore the 1% decline experienced by Foxtons reflected market share gains in higher-value properties, which is in line with strategy.

The decline in revenue and the investment in the sales business to ensure the operation is ready and can capitalise on improved market conditions resulted in operating losses widening materially in the period, from £3.2m in 2022 to £10.0m in 2023. The drop-through rate of declining revenue was in excess of 100% and was further exacerbated by higher than usual cost inflation. We believe that 2023 marks a low point for Sales revenue and profit, and anticipate some recovery in future periods.

The chart below shows the volume of sales, revenue and revenue per unit over the last 10 half years. It shows half-yearly volumes in 2023 of c 1,300–1,600, up c 18% versus c 1,200 in H119 and H219. Revenue per unit is broadly unchanged, implying that total revenue was also up by a mid-teens percentage in FY23 versus FY19.

Foxtons’ Financial Services division handled 5,033 units in the year, which was marginally up on FY22. Revenue and revenue per transaction were both down by c 14%, to £8.8m and £1,745 respectively, reflecting lower average loan sizes, a reduction in new purchase volumes and an increase in lower-value product transfers within the refinance business. Of the £8.8m total revenue, £4.4m (broadly flat year-on-year) was from non-cyclical refinance activity and £4.3m (FY22: £5.7m) was from more cyclical purchase activity.

Operating profit in the segment declined to £0.7m (FY22: £1.8m), with the operating margin also weakening, from 17.3% to 7.4%. Over the last 10 half years, volumes have trended modestly higher, but in 2023, revenue per transaction was cyclically lower, which depressed overall revenue down to levels similar to that seen in 2019, pre-pandemic. Financial Services remains the smallest division of the group by a long way, but it is profitable and it is a complementary component of Foxtons.

Foxtons reported that trading in January and February had been in line with expectations. The Lettings business has strong recurring revenue and is expected to remain resilient. The demand and supply dynamics of the lettings market appear to have normalised, with an increased level of available stock and fewer tenants registering for each property implying good demand, and stable pricing at the prevailing elevated levels. Foxtons remains very optimistic that its Operating Platform will continue to deliver market share growth.

In Sales, the under-offer pipeline was up 31% in value terms at the end of February, reflecting better demand characteristics as mortgage rates have begun to reduce, and continued market outperformance. This bodes well for first half revenue, with Foxtons optimistic that H224 could also offer growth if mortgage rates stabilise and pent-up demand is released. In Financial Services, new buyer demand has improved along with non-cyclical refinance activity, which supports a 16% improvement in the Financial Services pipeline.

Should these levels of demand persist for the full year, our modestly revised forecasts below may look conservative, implying that risks may ultimately be to the upside.

Foxtons modesty exceeded our FY23 expectations at the operating profit level and we have flowed this into our FY24 and FY25 estimates, which results in a modest profit uplift as described in the table below. The only material change is the improvement in net debt/cash expectations as the investment in working capital normalises. We do not include M&A in our forecast years, so should Foxtons engage in further consolidation, our estimates would need to be reviewed.

We have also introduced FY26 estimates (see Exhibit 10), which include operating profit of £25.2m and an operating margin of 15%, which are in line with medium-term targets.

After some unhelpful macroeconomic trends over the last two years, we believe the outlook is improving. Accordingly, we have modestly raised forecasts and introduced FY26 numbers, which are in line with strategy. We have also reviewed, simplified and updated our valuation methodology to include c £20m of M&A investment in Lettings, also in line with the strategy. This revision results in a modest valuation upgrade, from 127p/share to 132p/share.

We have moved away from our previous valuation model as it has become less relevant, and adopted a simplified multiple-based valuation. Our new valuation model is detailed below and is based on our new FY26 earnings, which are in line with the company’s stated medium-term target (operating profit of £25–30m and an operating margin of 15%). The first FY26 column is based solely on our FY26 forecasts and, with a 17.5x P/E multiple applied, gives a value of 100p/share. The multiple applied is the average multiple that Foxtons traded on in 2014 and 2015, when arguably the outlook was as positive as it is now.

Our preferred valuation is the FY26 (including M&A) column, which is the same as the first, but includes an assumed £20m of M&A spending in Lettings in total in FY24 and FY25, which generates an additional £11m of revenue, in line with previous guidance, with an assumed 50% drop-through rate to operating profit. This level of M&A investment is broadly in line with the last four years, where Foxtons invested a total of £47.4m, or c £12m pa. Excluding FY20, the first COVID year, Foxtons has invested an average of c £14m pa on internally funded acquisitions of predominantly Lettings revenues.

This valuation methodology results in a slight upgrade from 127p/share to 132p/share, implying c 130% upside.