Over the next few weeks we will be discussing the Boyd Group Income Fund (“Boyd”), one of the world’s largest collision repair operators. As of the date I’m writing this, Boyd owns and operates 340 collision repair facilities in North America under the names Boyd Autobody & Glass in Canada and Gerber Collision & Glass in the U.S. (amongst other co-branded names such as Champ’s Collision Centers and Craftmaster Auto Body). Boyd also has a significant retail auto glass operation in the U.S. The company trades as a unit trust on the Toronto Stock Exchange and has an enterprise value of over a $1 billion (all values are in Canadian dollars unless otherwise indicated). Enterprise value is the total value of the company, including net debt (total debt – cash) and equity.
Because Boyd is publicly traded, it is required to file quarterly and annual reports outlining the financial performance of the company. Every three months the company files a report that includes an income statement (also called a Statement of Profit/Loss or a profit and loss statement), a balance sheet (also called a Statement of Financial Position), and a statement of cash flows. It also includes a rather lengthy section of Notes to Consolidated Financial Statements where management discusses the results along with numerous footnotes further explaining the results from operations. You can access Boyd’s recent financial reports on their investor relations website.
This week we are going to review the first of the three key three financial statements from the 2014 annual report and compare the results to some industry averages. Next week we will look at the cash flow statement followed by the balance sheet. We also will calculate some operating and financial metrics used by Wall Street analysts to measure the health of a company. We will compare those to similar industry KPI’s that you may be more familiar with and perhaps give you a few new metrics in which to evaluate your company. After that we will look at what is perhaps my favorite section, acquisition history, and with a little bit of math, divine some general observations about price and terms in collision repair transactions. But before we can talk about acquisitions, we have to cover some basics in the income statement.
Income Statement (Consolidated Statements of Loss, pg. 51)
The income statement is broken down into a few key areas: sales, gross profit, operating expenses, and other expenses. Beginning on page 19 of the 2014 Annual Report, management discusses the financial results for the year. The financial statements themselves begin on page 49 (a copy of the income statement is found on page 51). Management covers a lot in their discussion but some of the highlights are as follows:
Sales increased by 46% in 2014 to a total of $844 million. The bulk of the growth in sales, $158 million, was a direct result of acquiring other collision repair businesses. But after factoring out acquisitions, same store collision sales (i.e., sales at stores that have been operating for at least 12 months) increased 7.2% to $535 million. In total dollars same store collision repair sales increased by $36 million and glass sales increased by $43 million. The company also benefited from a $33 million exchange rate translation between U.S. and Canadian dollars. Keep in mind that references to “2014” are for the fiscal year, which coincides with the calendar year, and that total sales includes both glass as well as collision repair services.
Many smaller MSOs and single or dual location businesses find it challenging at best to expand same store sales by any amount in the current economic environment. While 2014 was generally an up year in the collision industry, many companies, public and private, are hard pressed to consistently achieve a 7% top line growth rate. This is an ongoing testament to the attractiveness of the multi-store business model in the collision industry.
Gross Profit Margin
Boyd reported a gross profit of 46.2%, an increase of 0.2% from 2013. Gross profit increased primarily as a result of higher paint discounts over the year. Boyd re-negotiated its paint contract in late 2013 from a “pre-bate” to a traditional back-end discount. While the company was able to negotiate a substantial discount in paint materials, they were required to pay $35 million in cash to exit the contract early and compensate the paint vendor for “unearned pre-bates”.
A common misconception in the industry is that the large consolidators operate at relatively low gross margins. Many erroneously believe that due to purported discounts large consolidators provide to carriers on parts, labor, and materials that gross margins are consistently less than 40%. However, what is missing from that analysis is that the large consolidators have significant negotiating powers with vendors. In order to consistently maintain gross margins above 45% while purportedly providing substantial discounts is a testament to the negotiating power scale provides. (Editor’s Note: Read Brad’s recent article in Aftermarket Business world on how consolidation in the collision industry is impacting the paint distribution and jobber industry).
Additionally it is important when comparing one business to another to ensure that the comparison is truly comparable, or “apples-to-apples”. For example, some collision companies put all expenses relating to direct labor (such as payroll taxes and benefits) into Cost of Sales, thus reporting a relatively lower gross margin. Others put all employee-related costs into Operating Expenses creating a very high gross margin. Cost of Sales sold typically includes parts, materials, sublet and direct labor expense. In the collision industry, direct labor typically refers to any labor performed directly to a vehicle and includes labor performed by metal technicians, helpers, painters, preppers, and detailers.
With respect to Boyd’s presentation, the company does not go into this level of detail when outlining its accounting policies in regards to Cost of Sales. However, generally direct labor expenses are included in cost of goods sold whereas administrative employees, estimators, managers, payroll taxes and benefits are considered general administrative expenses. Utilizing these figures, the average collision repair facility ought to have a gross margin of 40% to 45%.
Operating Profit Margin
After accounting for overhead expenses such as executive and regional management, administrative personnel, rent, insurance, utilities, etc., Boyd had an operating margin of 8.2%, a significant improvement of 1.0% from the year prior. As the company grows, it is able to spread fixed and administrative costs over a wider base of sales. In other words, the company is able to grow sales at a faster rate than operating expenses. The result is that the company is able to consistently increase operating margins as the business grows, developing economies of scale.
An average operating profit for the industry is difficult to estimate due the vagaries of owners in applying standard accounting principles as well as the tendency for special one-time discretionary business expenses on the books. Operating margins for healthy, privately-owned collision repair operators can be anywhere from 8% to 18%, depending on specific cost structure and accounting policies. Boyd’s operating margin of 8.2% is respectable, but the ability to drive a 1% increase in operating profit is of particular note. As the company is able to continue to leverage scale and streamline operations, operating margins will continue to expand.
It is important to keep in mind the impact corporate overhead has on earnings when comparing Boyd’s financial position to smaller MSOs and single or dual location businesses in the industry. Corporate overhead would include many expenses that a smaller operator would not have, including executive management, regional and area management, human resources, legal, accounting, audit, tax, treasury, strategic planning, corporate development, information technology services, and environmental and compliance management to name a few. Put differently, one would expect a smaller company to have substantially less corporate overhead and operate at a relatively higher operating margin relative to a large multinational entity.
Net Profit Margin
After accounting for a host of additional expenses including acquisition and process improvement costs, depreciation and amortization, finance costs, fair value adjustments, and income tax expense, the company reports a negative net profit of $15.3 million, or a loss of 1.8%. Many of these expenses are “non cash” or accounting expenses rather than actual expenses that are payable in a given period. The impact of these non-cash expenses creates a company that is not profitable from an accounting perspective despite its ability to generate substantial cash.
Perhaps the most significant factor in Boyd’s net loss has to do with the legal structure and accounting standards. Differences in accounting standards between the U.S. and the rest of the world require Boyd to recognize certain expenses (fair value adjustments) related to future financial liabilities associated with certain types of shares and obligations (if you are interested in a wonky discussion about the differences in GAAP and IFRS and how mark-to-market accounting principles vary cross border shoot me an email via the contact page and we can geek out together).
In 2014 Boyd recognized over $37 million in non-cash fair value adjustments. Factoring out these adjustments as they are generally outside of management control as well as other unusual and infrequent adjustments the company would have reported positive net earnings of $30 million. These non-cash expenses are a unique but significant example how accounting policy and legal structure can materially impact the reported profitability of a company, both public and private.
EBITDA (which stands for earnings before interest, tax, depreciation and amortization) is a non IFRS / GAAP financial measure, which means a reader will not see it listed on the income statement. In corporate finance, EBITDA is used to adjust for different capital structures and investment levels in fixed assets like property and equipment. It is also commonly used in valuations and financial covenants. For example, Boyd has a number of debt covenants that are based upon debt to EBITDA ratios. Debt covenants are restrictions that protect a lender by limiting the activities of a borrower. Management discusses EBITDA on page 14 and specific debt covenants beginning on page 25.
EBITDA is an often utilized financial measure because it approximates cash flow; but, is not an exact match (we will discuss this in more depth next week). Companies often make additional adjustments to EBITDA in order to provide additional insight into the nature of the business and strip out one time or unusual expenses. In Boyd’s case the company makes additional adjustments including special one-time gains or losses, fair value adjustments (discussed above), and acquisition and process improvement costs which are cash expenses, but not directly related to ongoing operations of the firm.
In 2014, Boyd’s adjusted EBITDA was $69 million, an increase of 66% from the year prior. Recall that sales only increased 44% and gross margins remained about the same. However adjusted EBITDA margins as a percentage of sales increased to 8.2% from 7.2% in 2013. Substantial growth in both adjusted EBITDA as well as adjusted EBITDA margins demonstrates the ability of the company to successfully execute on its stated growth plan. We will talk more about cash flows in the next installment.
We covered a lot this week, but we have only just begun. Next week we will look at the cash flow statement, an area that says a lot both about the health of the business as well as the strength of the management team. When I was getting my MBA and working as an equity analyst, I learned that to better understand the strength of a company, it is always best to look directly at the statement of cash flows. Boyd’s cash flow statement gives the impression of a very well-managed company.
I’m eager to hear from you. How has consolidation affected you? Have you attempted to grow like a consolidator or are you considering an exit because of consolidation? Shoot me an email via my contact page to discuss further as we explore Boyd together. I find the transformation in the industry truly fascinating and all communication is kept strictly confidential.
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