LSL Property Services: a profit-machine in the property sector

Property is a national obsession for the British. There are no fewer than seven house-price indices providing a month-to-month update on house prices and the reports make headline news. The total value of UK residential property stood at nearly £9 trillion at the end of 2022, according to the global real-estate group Savills – several times higher than the collective worth of all equities listed on the London Stock Exchange (£2 trillion). The value of all residential property in the UK is around 4.5 times higher than the total value of the equity market. In the US, the ratio is closer to one-to-one. 

There are 900,000 residential property market transactions every month, with £10 billion of transaction volume, according to HMRC. This makes the residential property market far more important and liquid than the UK equity market. But it is staggeringly inefficient. The market is dominated by thousands of small firms: estate agents who help buyers and sellers find properties, conveyancers who do the paperwork, surveyors and mortgage brokers. That’s not to mention all the ancillary firms, such as insurers, movers and other contractors – heating engineers, for instance, who may need to compile energy performance certificate (EPC) reports. 

Inefficiency is always bad news for consumers, but it’s great news for businesses. Inefficient markets allow companies to book extra profits thanks to excessive profit margins. For example, despite numerous efforts by companies to try to offer a free estate-agency model, the commission-based model dominates. Commissions of 1%-3% are common, and buyers often rely on mortgage brokers to navigate the mortgage market. There are thousands of products on the market, which even the most savvy buyer would find impossible to navigate. These complexities and inefficiencies enable LSL Property Services (LSE: LSL) to earn a return on invested capital – a measure of profit for £1 invested in the business – in the mid-30% range. This rate of return is rarely seen beyond the technology sector.

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What's behind LSL's success?

LSL has become a one-stop shop for property transactions in the UK. The company has three main divisions: surveying and valuations (50% of revenue), estate agency and financial services. This model means it operates at every stage of the property value chain and is well-positioned to benefit from a bounce back in activity. 

LSL has made several major changes to its business model over the past few years, which puts the business in a much better position today than it has been for several years. The biggest has been the shift in its estate-agency arm from a fully operated to a franchising model. Last year, the group moved its estate-agency brands, including the likes of Your Move and Reeds Rains, into a franchise model, whereby the cost of operating the business was shifted on to franchisees in exchange for a share of profit. The group’s headline revenue number fell from £217.5 million to £144.4 million, but costs for the division should be slashed from £125 million to £2.5 million. In the first six months of 2024, the group reported an operating profit margin of 24% from this arm, up from 4%. The new model also provides greater operating leverage in a rising market. Restated revenue rose 79% to £12.9 million in the first half. 

The other major change management has pushed through in the past year was the sale of LSL’s direct-to-consumer mortgage broker arm to Pivotal Growth, a joint venture between LSL and private equity group Pollen Street Capital. The £200 million joint venture has snapped up other brokers since the merger and has over 450 mortgage advisers with a market share of 11.1%. Its largest peer, the Mortgage Advice Bureau, has a market share of 8.1%. LSL’s asset-light model, focused on joint ventures and franchises, puts it in a good position to generate healthy profits as the property market recovers. Its last division, surveying and valuations, has been hampered by management’s decision to maintain capacity for normal market conditions as the market slowed, although this is now paying off. In the first half, the division booked revenue growth of 31%, with the profit margin recovering from 10% to 26%. Its share of the UK market rose from 39% to 40%.

Should you invest in LSL?

The company has reported “messy” earnings for the past two years. Its 2022 numbers were marked by a large goodwill write-off, which led to a reported loss before tax of £59 million. The figures for 2023 were affected by the franchising changes and the asset sale to Pivotal, not to mention the volatility in the UK mortgage and housing market. Now, the company and the wider UK housing market have got through their respective periods of change, and LSL’s outlook is bright. Analysts at investment bank Peel Hunt believe the company will report earnings per share of 20.2p for 2024, the first “clean” year of earnings after the changes, putting the stock on a price-to-earnings (p/e) ratio of 16. 

Its interim results showed growth of 18% in group revenue and a rise of 354% in underlying operating profit to £14.4 million, while earnings per share jumped 325% to 11p. With earnings growth of 24.6% pencilled in for 2025 and 20.6% for 2026, that ratio could fall to 10.7 by 2026. Financial services group Zeus Capital is slightly more downbeat about growth. But its analyst, Robin Savage, notes that the valuation “includes substantial net cash” (£35 million at the end of 2023) and the recent first-half results “provide evidence supporting our view that LSL’s operating performance will materially improve in 2024 and 2025”. There is also a 3.5% dividend.

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