For many investors looking for value, the Peter Lynch Screener is a good source of ideas and prospects. One of the 14 stock names currently listed on the screener describes itself as “a full-service commercial real estate financial intermediary.” HFF Inc. (HF) is a young company with a market cap just over the $1 billion.
The Peter Lynch Screener uses one of the famed mutual fund manager’s techniques to find stocks. It compares a company’s share price with what the shares would be worth if they were priced at exactly 15 times earnings. GuruFocus cites this excerpt from Lynch’s book, "One Up on Wall Street."
“A quick way to tell if a stock is overpriced is to compare the price line to the earnings line. If you bought familiar growth companies – such as Shoney’s, The Limited or Marriott (MAR, Financial) – when the stock price fell well below the earnings line and sold them when the stock price rose dramatically above it, the chances are you’d do pretty well.”
As this chart shows, HFF’s share price currently falls below the 15 times earnings line, suggesting it is undervalued:
In this article we’ll take a look at HFF’s business, its prospects and its valuations.
History
1982: The company’s principal predecessor, Holliday Fenoglio & Company, founded in Houston.
1994: Purchased by AMRESCO Inc. to create Holliday Fenoglio Inc.
1998: After an acquisition, the company becomes Holliday Fenoglio Fowler LP.
2003: A management buyout, and the company is renamed HFF Securities LP.
2007: The company goes public on the New York Stock Exchange and (eventually) becomes HFF Inc. (symbol HF).
The company summed up its history in its second quarter earnings conference call:
Comments: A company approaching the 10th anniversary of its public life, following a series of acquisitions and reorganizations.
HFF’s business
Perhaps the best way to get a sense of what this holding company does is to look at a few recent headlines from its news releases:
- “HFF Closes $305 Million Sale of Novo Nordisk’s (NVO, Financial) Headquarters in Princeton, New Jersey" (Aug. 15).
- “HFF Arranges $121 Million Sale and $49 Million in Financing for Orlando-Area Regional Power Center" (Aug. 15).
- “HFF Secures $155.83 Million Financing for Development of Luxury Apartment Tower in Jersey City” (Aug. 4).
In its 10-K for 2015, HFF outlined the services it provides in more detail (unless otherwise noted, information here comes from the company’s 10-K for 2015):
- Debt Placement Services: It offers a complete range of debt instruments, which includes construction and construction/mini-permanent loans, adjustable and fixed rate mortgages, entity level debt, mezzanine debt, forward delivery loans, tax exempt financing and sale/leaseback financing.
- Investment Sales Service: Investment sales services to commercial real estate owners trying to sell properties or property interests.
- Equity Placement and Private Equity Services: providing financing alternatives at all levels of the capital structure, including mezzanine and preferred equity. This can provide potential buyers and existing owners with the highest appropriate leverage at the lowest blended cost of capital.
- Private Equity, Investment Banking and Advisory Services: Through its licensed broker-dealer subsidiary, it offers clients access to private equity markets, discretionary private equity funds, joint ventures, entity-level private placements and advisory services as well as structured finance services.
- Loan Sales: help clients sell commercial real estate debt note portfolios, which can include performing, nonperforming and distressed debt and/or real estate owned properties.
- Commercial Loan Servicing: commercial loan servicing (primary and subservicing) for life insurance companies, Federal Home Loan Mortgage Corporation (Freddie Mac), and Federal National Mortgage Association (Fannie Mae).
Comments: HFF offers six different services; from a competitive advantage perspective, this allows it to offer one-stop service to its clients. For investors, it means diversification and greater stability.
Revenues
This table from the 10-K for 2015 shows revenue for the past two fiscal years:
The following chart shows revenue growth over the past 10 years:
GuruFocus notes that HFF’s revenue per share growth has slowed over the past 12 months to 8.1%, compared to 19.4% on the same metric over the past three years.
Comments: HFF has done well on revenue growth since coming out of the recent recession, but growth over the past 12 months is less than half of what it averaged over the previous three years.
Competition
The company says all of its services operate in highly competitive environments, with “international and domestic commercial real estate service providers, institutional lenders, banks and savings and loans, CMBS conduits, insurance companies, investment banking firms, investment managers and accounting firms.”
Top competitors include “CBRE Capital Markets, Cushman & Wakefield, Eastdil Secured (owned by Wells Fargo [WFC]), Jones Lang LaSalle (JLL, Financial), Colliers (CIGI, Financial), Cassidy Turley, Walker Dunlop, Marcus & Milichap, Newmark/Frank, Northmarq Capital (Marquette), Meridian and Berkadia.”
In its second quarter earnings conference call, the company noted that the brokerage industry has been consolidating, to its advantage:
Comments: With its strong growth (albeit slowing in the past year) and consolidation, HFF has carved out a leading spot despite the competition.
Moat
In its 10-K, the company says it has several competitive strengths:
- Experience: Between the current company and its predecessor firms, the company has been in the commercial real estate business more than 30 years, and its 290 transaction professionals have an average of 17.0 years of commercial real estate transaction experience.
- The Captrack Database: allows it to analyze all commercial real estate product types and markets. In turn, it can provide clients with analysis, advice, and execution expertise.
- Independent Objective Advice: “We do not currently offer services that compete with services provided by our clients such as leasing or property management, nor do we currently engage in principal capital investing activities which would compete with a number of our clients.”
- Extensive Cross-Selling Opportunities: Players in the commercial real estate market often adopt different roles, as buyers or sellers, and lenders or borrowers at various times, and HFF is positioned to assist them in each of those roles.
- Broad and Deep Network of Relationships: many long-standing connections with users and providers of capital and experience serving leading institutional commercial real estate investors.
Comments: While none of the company’s competitive strengths provides an absolute barrier, they all count in an industry that depends heavily on networking and personal connections (and in this case, backed up with proprietary database information).
Growth
HFF also outlines its growth plans in its 10-K:
- "Increase market share across each of its capital markets services.
- "Continue to capitalize on cross-selling opportunities.
- "Expand its geographic footprint.
- "Align its leadership and compensation structures with our long-term growth."
Comments: The company has used each of these tactics in the past, and we see no reason to believe it can’t continue to capitalize on them.
Other
The company incorporated in Delaware, and its head office is in Pittsburgh.
Mark D. Gibson, age 56, is vice chairman of the board and CEO of HFF. He is one of the founding partners, having joined predecessor firm Holliday Fenoglio & Company in 1984 (based on information from reuters.com).
HFF employed 810 people as of Dec. 31, 2015.
Ownership
As we’ll see below, institutional investors hold a big piece of this company; however, only two of the gurus followed by GuruFocus have holdings in HFF. Jim Simons (Trades, Portfolio) owns 593,100 shares, and Paul Tudor Jones (Trades, Portfolio) has a modest holding of just over 11,000 shares.
As noted, institutional investors have a large share while insiders have a respectable share:
The following illustration from the Q2 Earnings Conference Call Presentation shows how insiders are incentivized:
Comments: We don’t see many familiar faces from among the gurus, but nevertheless, institutional investors like this company, and insiders have a growing stake in HFF’s growth and profitability.
HFF by the numbers
Although it normally does not pay a dividend, the board of directors did declare a special dividend of $1.80 per share in January 2015 (and paid the following month).
Comments: The 45% ROE stands out among the statistics cited here; otherwise, the share price is closer to its 52-week low than its high for the same period. It usually does not pay a dividend, and it issued an additional 400,000 shares in 2015.
Financial strength
HFF receives a medium rating for financial strength and a strong rating for growth and profitability, based on 10 years of financial results:
The company carried only half a million dollars in long-term debt at the end of fiscal 2015, and at the end of the second quarter of fiscal 2016 had reduced that amount to some $300,000.
It has demonstrated earnings power, with a three-year average EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) growth rate of 34.20% (that rate may slow with 2016’s full-year earnings):
We note that GuruFocus gives HFF a lowly 1-Star (out of 5) rating for the predictability of its earnings.
Free cash flow has also grown, bumpily:
And earnings per share (EPS) grew over the five years that ended on Dec. 31, 2015:
Comments: HFF is not debt-free but carries a relatively small debt load and until the end of 2015 posted strong metrics on all essentials. More recently, growth has become an issue.
Valuations
GuruFocus suggests, “HFF is more suitable for Earning Power Based valuation methods. This includes 1) Median P/S Value 2) Peter Lynch Fair Value. The Median P/S Value of HFF Inc for today is $26.05. The Peter Lynch Fair Value of HFF Inc for today is $51.73.” The price at closing on August 30, 2016 was $26.82.
Here, again, is the Peter Lynch chart, after closing on Aug. 30:
The DCF Fair Value calculator brings in a price that’s 16% below the current share price:
Note, as the calculator warns, “Result may not be accurate due to the low predictability of business.” Without consistent earnings, we have to be cautious about any result based on extrapolating earnings 10 and 20 years out into the future. As you will recall, HFF has a 1-Star predictability rating.
To this mix of valuations we’ll bring in another Peter Lynch favorite, the PEG ratio, which is the P/E divided by the average earnings growth rate over the past five years. Currently the PEG ratio sits at 0.47 which suggests strong undervaluation (a ratio below 1.0 suggests the stock is undervalued; a ratio between 1.0 and 1.9 suggests fair valuation, and a ratio above 2.0 suggests overvaluation).
Comments: We have a range of valuations from which to choose; both of the Lynch tools suggest the current price does not properly reflect the full valuation of HFF, Inc.
Conclusion
The Lynch chart and PEG ratio probably have it right; the stock probably is undervalued based on the strength it displayed in the past.
Normally, we might say this is a small cap and might move radically (one way or the other) at any time. However, it’s also very much an institutional stock; since the pension and mutual fund managers can’t move too much stock at a time without tipping off the rest of the market, they move slowly. That might dampen any sudden price movement.
Despite all of that, this remains a small cap stock with some debt, so it will not suit every value investor. However, for those willing to reach a bit, HFF holds the potential of substantial capital gains.
Disclosure: I do not own shares in any of the companies named in this article, nor do I expect to buy any in the foreseeable future.
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