Franchise Brands offers growth at a reasonable price

Plumbing, environmental and industrial services company Franchise Brands (FRAN) transformed its business with a big acquisition last year and management is now promising a period of impressive profit growth.

This is Franchise Brands’ first full-year result since it completed the major acquisition of hydraulic hose replacement business Pirtek for £211mn. Pirtek now makes up 35 per cent of revenue.

The deal was funded with £100mn of bank debt and £114mn of equity. Correspondingly, the deal swung the business from a net cash position of £8.2mn to a net debt position of £82.3mn. This is equivalent to 2.48 times the adjusted cash profit (Ebitda) and management has said it won’t be making any more acquisitions until it has paid down a significant portion of this debt.

The Pirtek deal has gone well thus far. Eight months on, it is now trading at record levels. The aim is that as Pirtek is integrated into Franchise Brands' IT systems, costs will reduce and margins will rise. Currently, Pirtek’s 73 franchises work on fractured management and financial systems.

This strategy of bringing businesses together onto a centralised IT, management and financial system is a core part of Franchise Brands’ growth strategy. It lets all the individual businesses get on with their own work, but then lowers operating costs with more efficient central management.

For the whole business, the medium-term outlook is for revenue to compound at between 11 and 12 per cent, rising to £600mn by 2027. As the company grows, it should benefit from operational gearing, which means management is forecasting that the adjusted cash profit margin will rise at 30 basis points per year. It isn’t often companies give such specific medium-term targets, so this shows a strong degree of confidence in the company's direction.

A problem is how much of this cash profit will be turned into statutory profit given the interest repayments required on the debt. Last year, adjusted cash profit doubled to £30mn but after £5mn of finance expenses plus increased amortisation and depreciation costs, statutory profit dropped from £8mn to £3mn.

The shares were knocked on results day by management comments pointing to demand softness in the construction and fleet hire sectors. Still, the hope will be that as the operational leverage kicks in, operating profit will rise and the debt will be paid off. Broker consensus compiled by FactSet forecasts that adjusted earnings per share will rise to 9.4p in 2024 and then to 12.6p in 2025. This gives an affordable 2025 price/earnings ratio of 12. Short-term forecasts may come down, but nonetheless at this enticing price we like the business model and stick to buy.

Last IC View: Buy, 135p, 16 Nov 2023