AGB 2021.8 - Boyd Group Services (BYD.TO)

Roll-Up to Scale Advantages

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Boyd Group Services

Boyd Group is the 2nd largest collision repair shop operator in the U.S. (610 locations) and #1 in Canada (131 locations). The company does business under the Gerber Collision & Glass brand in the U.S. and Boyd Auto Body & Glass and Assured brands in Canada. Most of the company’s growth over the past 10 years has been in the U.S. (with the exception of the Assured acquisition in 2017) because the U.S. market is much larger and private auto insurance (vs. government operated) is the norm.

The collision repair market is $40B in the U.S. and less than $3B in Canada with 90% of the payments coming from insurance companies and 10% direct from consumers. Because the bulk of the dollars are directed by insurance companies, DRPs (Direct Repair Programs) are the lifeline for many of these collision repair shops. Each insurance company has its own referral relationships with collision repair shops within a region of coverage. What the insurance companies are looking for are (1) high quality repairs with low costs, (2) minimization of administrative tasks/costs, (3) and speed of completion.

Many insurance companies are opting to manage fewer of these DRPs with a select few large operators. And it makes sense that this is the trend because the quality of repairs should be more consistent (and hopefully better) with MSOs (Multiple Store Operators) and there would be fewer relationships to manage. Boyd does claim that its speed to completion is 20% better than the industry average, but it’s uncertain how that compares to the other large players in the market.

There is also the trend of car parts becoming more complicated and expensive. This has put pressure on margins for the industry as the margins on parts is much lower than the margin for labor. And given that there are many shops willing to compete for a job, it may be difficult for the collision repair shops to pass on price increases for parts systematically. Many insurance companies are also leaning towards shops having certain OE certifications, which is another added cost.

Because of these dynamics, many single shop owners have either gone out of business or sold to a larger operator over the past 10 years. Large MSOs have increased their share in terms of revenues from 11% of the market in 2010 to over 30% in 2019 and 3% to 10% in the number of locations over the same time period.

The three largest MSOs are Caliber Collision (1,100+ locations), Boyd (741) and Service King (335). Both Caliber and Service King are owned by private equity firms, which are pursing similar strategies to Boyd’s. Single shop locations and smaller MSOs are being rolled up by the large firms, and from all accounts, the PE backed firms are being much more aggressive with leveraging their balance sheet (4x-7x Debt/EBITDA) to do so.

For the collision repair industry, there are some concerns around the LT size of the market since ADAS (Advanced Driver Assistance Systems) and autonomous driving could lead to lower accident rates in the future. Industry data show that the % of new cars with ADAS systems built-in are increasing every year and collision frequency has come down over the past 4 years. The company, using industry estimates from CCC, is assuming that collision frequency goes down by -11% 2025, -19% by 2030 and -35% by 2050.

However, the flip side to that coin is that the severity of collisions are also increasing, leading to higher costs to repair. There is a fine balance, at least from the insurance companies’ points of view, on whether cars are sent for repairs or sent to a salvage auction as costs to repair move higher. Using aftermarket parts make the cost of total repair lower.

Boyd has been aggressively acquiring collision repair locations where it fits the company’s return profile. To illustrate this point, growth by SSS has averaged 4.2% from FY11-FY19, whereas growth from acquisitions + new stores (most of which is acquisitions), has averaged 23.7% for the same time period.

In 2015, the company set a 5 year growth plan to double revenues, which they reached in the first quarter of 2020 (annualized). In November of 2020, the company again announced its intention to double the revenues from 2019 levels by 2025, which would imply a 17% CAGR off of 2020 revenues. There aren’t LT margin targets set, but 10% EBITDA margins has been alluded to as a near term target, which should be manageable given 2019 EBITDA was just shy of 10%.

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Why is it a good business?

A single collision repair shop doesn’t have many competitive advantages. Other than a star technician (cannot be replicated) or specialization in repairing certain parts of a car (e.g. transmission), there isn’t a structural advantage for the single collision repair shop.

It’s a bit better for the large MSOs as they have scale economies for sourcing parts cheaper or being able to negotiate lower borrowing costs. Having density within a certain region also helps mitigate any spikes in demand as large MSOs can spread new repair jobs across more locations for smoother utilization.

The greatest advantage that large MSOs have are the DRPs with the insurance companies. We know that insurance companies are moving towards fewer relationships with larger MSOs and in the U.S., auto insurance underwriting is concentrated with the large insurance companies. Large MSOs can leverage their DRPs to forecast the upside potential of acquiring new locations with greater precision.

Analyzing the business quality of the leading MSOs is interesting because the largest and third largest players are private. So while Boyd is a public company, it’s difficult to compare metrics to verify claims of superior business strategy or capital allocation efficiency. And after doing all the reading possible in two weeks, there isn’t much to say about differentiation among the top three MSOs.

But when you look at Boyd specifically, the return numbers look great. In fact, it’s one of the most consistent in terms of returns and because the reinvestment rates have been high (between 70%-85% with the exception of 2020), the growth in value has been one of the best among retail/location companies that we’ve analyzed.

So, at this level of analysis it may be okay to conclude that Boyd has some process power advantage. (Much more work can be done by visiting locations of Boyd and their competition to figure some of this out). The company speaks about its Wow Operating Way, which is a series of best systems, processes and measurements that Boyd applies at all of its locations. The idea is that the company strives to aim for consistency of outcomes for customer satisfaction.

It may also be the case that while a large MSO isn’t in the top tier of business quality, the fact that the industry structure is so fragmented and that acquisition multiples available for single shop operations still imply very attractive returns, the consolidators of this market have benefited. So while the business quality may only be better than average, the favorable industry structure makes up for some of that.

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Returns on capital?

Over the past 10 years, Boyd has spent 89% of its capital on acquisitions, 13% on capex and 1% on software licensing, offset by 2% on sale of assets. Similar to the other large MSOs, Boyd has grown mainly through acquisitions of both single shops and strategic smaller MSOs that have a presence in certain regions.

Single shop operators are usually looking to retire after running the family business and walk away once a transaction is closed. Because of this fact, it’s difficult to differentiate as a buyer other than price and terms. A MSO management team usually stays on after an acquisition and Boyd has stated that the company prefers to use stock as part of the deal terms to keep these managers properly incented.

While accurate unit economics aren’t known, the rough numbers (at least for Boyd) are 25% pre-tax ROIC for single shop locations for a multiple below 4x EBITDA. Boyd has commented that they typically acquire these stores in the C$400k-C$600k range. If you assume EBITDA margins including synergies of 9%, it would imply that C$1.1M-C$1.7M range for revenues for single shops.

Just by comparison, the average Boyd owned shop has ranged between C$3.3M-C$3.7M for the 5 years prior to 2020. Because of this wide gap, we can conclude that capacity utilization at most shops are not near 100%, even if the shops are smaller. Furthermore, we can also assume that Boyd likely improves the utilization at these stores (to get closer to the average number) after (1) implementing the Wow Operating Way and (2) leveraging existing DRP relationships within a certain region.

The returns for MSO deals are likely lower because larger targets have more negotiating power. For example, Boyd acquired Assured in 2017 for C$194M (C$146M in cash and C$48M in stock). The company got 68 locations in Ontario, Canada, almost half of which were intake centers at dealerships. Both Desmond D’Silva, CEO, and Tony Canade, President, stayed on after the acquisition closed and Tony is now the COO of Boyd.

Prior to the deal, Assured generated C$141M in revenues, implying a 1.4x EV/Revs multiple and a 8.3x EV/EBITDA multiple including synergies and tax savings. The 8.3x multiple would imply pre-tax ROIC of 12%, less than half of the 25% target for single shop operations. The Assured deal benefited Boyd in other ways, including a larger presence in Ontario, Canada as Boyd is now the #1 operator there and deepening relationships with the private insurance companies in Canada.

We estimate that Boyd has generated between 22%-29% returns on incremental capital invested over the past 5 years, excluding 2020. After FY18, the returns on capital were positively impacted from the lower corporate tax rates in the Tax Cuts and Jobs Act.

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Reinvestment potential?

One of the most interesting facts about the collision repair industry is that even after 10 years of the top 4-6 players consolidating the landscape, it still remains very fragmented. Over 60% of collision repair locations are still owned by single shop operators. Now, that’s not to say that consolidation hasn’t had any impact on the industry. Many single shop operations have closed down as larger, leaner operations with the backing of large DRPs have moved into their turf.

Boyd has been adding 80-100 locations annually since 2017 (except for 2020). For the company’s revenue growth rate to reach the high teens %, Boyd is likely going to have to acquire/build over 100 locations consistently. The company has recently expanded its corporate develop operations, something that needed to be done to grow from a larger base. While single shop operations have the best returns, the work put in by the corporate development team has to be considered.

There are also new store opportunities to go after and the return characteristics are similar, but the time to scale are different. Because an acquired single shop comes with a set of technicians, list of customers and DRP relationships, the time to maturity is longer for newly built locations.

There are still 32k collision repair locations in the U.S. and the large MSOs have over 10% of the locations. The runway to further consolidation should be fairly smooth, unless deal multiples go significantly higher from increased competition. As for Boyd, the company could be more aggressive in deploying its capital as the Net Debt/EBITDA has always been below 2x.

With a reinvestment rate between 70%-85% and returns on capital between 22%-29%, we estimate that Boyd’s intrinsic value has increased 19%-21% annually for the past 5 years.

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What else is important?

Covid impact

Collision repair really took a hit during the first two quarters of the Covid related lockdowns because miles driven are directly correlated to the frequency of accidents, which are directly correlated to revenues for collision repair. While auto parts retailers (ORLY, AZO) saw SSS increase through the pandemic as consumers had extra money lying around from the fiscal stimulus checks, collision repair shops didn’t benefit from that.

So far, miles driven has started to come back but congestion levels aren’t where they need to be for demand to be back where it was prior to Covid. Congestion is also a factor for accident frequency.

To mitigate the downside risk, Boyd took out a credit facility and a new seven year fixed-rate term loan to ensure the company had ample liquidity. Operationally, the company furloughed many workers and consolidated the workers that remained in fewer shops by region. Other locations were converted to intake centers (where customer just drops off and picks up) to increase capacity utilization at the locations that were fully up and running.

Acquisition activity was halted from March until August 2020 and WFH policies were implemented where possible.

Conversion from income trust to corporate structure

Boyd operated as a publicly traded income trust until January 2020. The conversion of the trust was done mostly in a tax free manner. The main reason behind the corporate structure conversion was that it allowed more foreign ownership of the company (mainly U.S. shareholders). There is a restriction related to Canadian regulation that limits the % ownership from foreigners for income trusts. Lifting this limit should allow the company to market more aggressively to U.S. based investors and thereby it should increase liquidity of the shares. This also opens the possibility of listing on a U.S. exchange in the future much easier.

What happens after consolidation?

If you believe in the sustainability of the return profile of the company and are comfortable about the LT implications of ADAS and autonomous driving, the logical next question is what happens when the large MSOs have consolidated the industry? It’s unclear what the % breakdowns will be at equilibrium, but one has to believe that the return profiles for acquisitions will come down, especially as the large MSOs jockey for position in key markets.

Is it better to be the largest player in specific geographies or regions? Or is it better to have a dense enough network of locations across almost all geos and regions? While we can’t really answer those questions, it will be interesting to see if process power and maintaining disciplined ROIC hurdles for acquisitions does actually make a difference in the long term for Boyd.

Optionality

When analyzing Boyd, it became more clear that there likely needs to be a phase 2 for this company at some point. And by phase 2, we mean that just consolidating the industry isn’t going to be enough for the company to sustain its current high levels of returns (look at the section above).

While the playbook doesn’t fully apply, it would be interesting if the company were able to take a page from another highly successful industrial roll-up company, HEICO. While the PMA process (read our analysis of HEICO for an explanation of PMA) is only applicable to FAA regulated parts, Boyd getting into the aftermarket parts business for autos as a manufacturer could be an avenue to vertically integrate. Just as an FYI, HEICO leverages its repair business to push its PMA parts onto its customers.

Vertical integration may be a way for Boyd to differentiate itself from the rest of the larger MSOs once a certain level of scale is reached in collision repair. Furthermore, insurance companies are already leaning towards mitigating costs by requesting the use of aftermarket parts for collision repair.

Has there been a precedent where an industrial distributor/customer moves up the value chain to manufacture their own products once scale is reached?

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