cemagraphics
Do you know the feeling of needing to communicate a difficult message? The type of message that feels mortifying to deliver. A message that may disappoint the person who’s receiving the message.
These messages are difficult to communicate, and probably difficult to receive. I recall the times in high school when I’d consumed too much alcohol… I was very good at not getting sick until seconds after I arrived home. Then I’d have to tell my hard-working mom what I’d been up to. Not fun.
While the circumstances will be different, there will be times when I’ll keep communicating during periods of poor investment performance. Our first two years together have gone well, and we’re all grateful. This will not always be the case, especially over shorter time periods. We’ll have individual years or longer periods where our performance will look less rosy.
Short-term challenging performance could happen for several reasons. Not all our investments will work out as intended. No one has a flawless investing record, and we expect our winners to create enormous value and more than cover for our more challenging investments. I also will continue to practice disciplines that will help me admit when an individual investment thesis has gone awry. Writing investment recommendations with pre-mortems detailing why I might sell are helpful tools to attempt to remove emotions ahead of time.
Another scenario is that we’ll go through periods of very challenging broader stock market performance that will impact our investments too. These will likely happen every few years. We know they will happen, but we don’t know when.
That’s to be expected. That’s OK. We are not investing to generate strong performance in any given month, quarter, or year. We’re investing to compound our wealth over multi-year periods. Our willingness to think longer term enables us to increase our odds of generating excellent investment performance and outperforming over longer periods of time.
Our goal is not to outperform when the market does poorly over a shorter period. This may happen, but it’s not our goal. Rather, the goal is to have the appropriate long-term mindset to weather the storm and take advantage of the volatility to improve our portfolio and generate better returns over the ensuing years. We endeavor to lay the seeds during challenging times that will bear fruit for many years to come.
When these shorter-term challenges happen, we’ll remain steadfast continuing to follow our processes. I’m always studying businesses, searching for the best long-term investment opportunities that can create significant wealth for us. During periods of market turmoil, businesses that we’ve researched in the past may suddenly have a high potential return, showing the value of our years of prior work. These habits will help us dampen any emotional challenges of watching our investments temporarily decline in value.
We’ll also remember that many of our investments use these challenging times to get stronger. They’ll innovate. They’ll earn their customers’ respect and gain market share. They’ll play offense when their competitors are forced to play defense. They’ll likely do it in a way that creates shareholders as well.
Many of the best opportunities present themselves during these times when the market is down considerably. Just in the last 5-6 years, there have been several good buying opportunities. The market sold off ~15% in December 2018. Then COVID-19 happened in early 2020 – fantastic businesses with great balance sheets and cultures were down 50% in some cases. A patient, clear-headed investor could think longer term than the daily news outlets and find great prospective investment opportunities.
These opportunities are never guaranteed. However, if a market-leading company can continue to think long term and invest its cash well above its cost of capital over time, the odds are in our favor that value will be created for equity holders over time.
Actually, this may be an extremely positive message. What could be more positive than the freedom of not having to focus too much on short-term results? We choose to trust in the value creation of excellent businesses, our analysis and our long-term mindset.
The commitment we make to each other is that we acknowledge that these times will happen. We’re prepared for them. We build our library of potential investments and we patiently seek out those opportunities where price disconnects most from a company’s intrinsic value. We’ll also be prepared to act.
Portfolio Spotlight: Boyd Group Services
On the topic of difficult conversations, let’s talk about car accidents. Womp womp. These situations are never fun. I can’t recall hearing that someone enjoyed even the most minor fender bender. Possible injuries, property damage, interacting with law enforcement, insurance companies and repair companies are some of the activities that usually don’t show up on our wish lists.
One such company that helps with these difficult situations is collision repair company Boyd Group Services (OTCPK:BYDGF). It happens to be Right Tail’s newest investment and one that I would not be surprised to see double in value in the next 4-5 years. Like many Right Tail investments, it’s a company I’ve been studying for a long time. I originally invested in the company in 2017 and have researched/invested in several companies which are tangentially related to collision repair.
Boyd owns ~950 collision repair locations across the United States and Canada. The business has produced a track record of incredible growth and returns on capital. Boyd is headquartered in Winnipeg, Manitoba, though 90% of its revenue is generated in the US. Its banner in the US is Gerber, which Boyd bought ~20 years ago. The company has an enterprise value of ~$6B.
Like several of our other investments, Boyd does many little things well, which is a great source of competitive advantage. They buy and grow many smaller repair shops. They remain fastidious on what they’re willing to pay for acquisitions, despite this becoming an industry that has attracted much private equity capital. In fact, as multi-site operators have become more expensive, Boyd has shifted its focus to buying single locations or building greenfields. They expected to receive 30% returns on capital for the greenfields though the returns take longer to achieve as the new sites mature. They balance growth and profitability rather than solely focusing on growth at any cost like many companies over the past several years. As a result, Boyd’s return on invested capital has typically been greater than 25%.
This fragmented industry continues to consolidate with the larger players leading the charge. The top 3 companies (Caliber Collision, Boyd, and Crash Champions/Service King) generate ~20% of industry revenue, a number which has grown significantly over the last 20 years though still leaves much room for further increases.
It’s a fun industry to research and develop unique insights with Boyd being the only company that is traded publicly.1 60-70% of the locations in the industry are still single store, mom and pops. Often these smaller companies don’t have the balance sheets to invest in technology to repair newer cars. I’ve spoken to a few operators and insurance partners who support our thesis. I have also needed to get some minor collision repair work done twice in the last year. Once I used a direct repair program and the other time I did not. My sense is that there are still big improvement that can be made to further optimize these repairs and make them easier on consumers.
Boyd provides significant value to its auto insurance partners and consumers. Consumers want their cars repaired well and quickly. If not, they may decide to change insurance providers. The insurance companies have preferred to establish Direct Repair Programs usually with the larger collision repair companies. The goal is to make the process as easy and simple as possible for the customer. The larger collision repair companies are usually better operators with the latest equipment to repair cars that are becomingly increasingly complex. Often the insurance company pays the collision repair company directly – in fact, 90% of Boyd’s revenue involves insurance companies. In inflationary times, collision repair companies need to raise prices to cover their costs and insurance companies need to get prices approved by their state regulators. This process typically works well, though time lags are normal.
I expect Boyd to compound at a high teens to low twenties rate of return. This rate of return is achieved by a 2-3% cash yearnings yield + 3-5% growth without reinvestment + 10-15% growth from reinvestment. The most attractive piece here is that Boyd invests nearly all its free cash flow at 25% or higher incremental rates of return. The least attractive part of the equation is the current valuation, but I expect the reinvestment opportunity to more than compensate us over a multi-year holding period. I expect Boyd to produce an IRR that I believe ranks near the top of our portfolio. Further opportunities exist if Boyd can get back to pre-COVID levels of profitability which have been impacted by higher labor rates or even higher levels of profitability as calibrating sensors on newer cars is a newer and higher margin opportunity.
I also like that this business is less economically sensitive. People will still drive and maybe even drive more during tougher economic times. Industry-specific risks could include a significant, permanent drop in accident frequency possibly driven by collision avoidance technology. Offsetting this risk is population growth, growth in miles driven and continued high levels of distracted driving. Another risk is that more cars are being declared total losses due to increased vehicle complexity and rising repair costs – that said, there continues to be more demand than supply for repair services and backlogs are often several weeks in advance.
Put it all together, and I think we have the chance for a five-year double or better with a management team that’s prudently allocated capital at high incremental rates of return. That it’s a less cyclical business is also appealing as we’ll encounter a recession at some point in the future. While getting in an accident is never a pleasant experience, I love how this company provides great value to its partners and hopefully will turn into a more than pleasant investment for us.
Best wishes for continued happiness and success as our investment journey continues,
Jeremy Kokemor
Right Tail Capital
1 Auto service company-driven brands has a franchised collision repair business that is a small % of its revenues and tends to focus more on oil change.
DisclaimerThis review (the “Review”) is being furnished by Right Tail Capital LLC (“Right Tail” or the “Firm”) for informational purposes only. This Review does not constitute an offer to sell, or a solicitation, recommendation or offer to buy, any securities, investment products or investment advisory services offered by the Firm (the “Offering”). Any offer or solicitation may only be made to prospective eligible investors by means of an Investment Advisory Agreement and Form ADV, which contain a description of the material terms relating to the Offering, including the numerous risks involved. This Review is being provided for general informational purposes only. Right Tail Capital (“Right Tail”) is registered as an Investment Adviser with the states of Virginia and Louisiana. Interested parties should read Right Tail’s Forms ADV I and II, available at adviserinfo.sec.gov. Certain information set forth in this Review is based upon data, quotations, documentation and/or other information obtained from various sources believed by the Firm to be reliable. No representation or warranty, expressed or implied, is made as to the fairness, accuracy, completeness, or correctness of the information and opinions contained herein. The views and the other information provided are subject to change without notice. This report and others posted on Right Tail Capital are issued without regard to the specific investment objectives, financial situation, or needs of any specific recipient and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Company fundamentals and earnings may be mentioned occasionally but should not be construed as a recommendation to buy, sell, or hold a company’s stock. Predictions, forecasts, estimates for markets should not be construed as recommendations to buy, sell, or hold any security — including common stocks, bonds, mutual funds, futures contracts, and exchange-traded funds, or any similar instruments. Investment strategies managed by Right Tail involve a significant degree of risk, and there can be no assurance that the strategy’s investment objectives will be achieved or that significant or total losses will not be incurred. Nothing contained herein is or should be relied upon as a promise, representation or guarantee as to the future performance of Right Tail’s strategies. Past performance is not indicative of future results. Images, graphics, logos, and other designs used in the Review are believed to be in the public domain. A reasonable, but not exhaustive, effort has been made to verify that such images, graphics, logos, and designs are not protected under copyright. However, if any party feels that this Review is in breach of copyright law, it should immediately contact the Firm. Performance data for the Right Tail Portfolio is based on the advisor’s brokerage account which was invested beginning on May 16, 2022. This performance figure has not been audited by any third party. Individual account performance will vary depending on a variety of factors, including the initial date of investment, inflows/outflows, account size, fee class, tax considerations, and transaction costs. Please see your individual account statement(s) for actual account balances and performance. Performance comparisons to benchmarks such as the S&P 500 Index and the SPDR S&P 500 ETF Trust (“SPY Index ETF”, “SPY”, or “S&P 500 Index ETF”) are provided for information purposes only. The SPY is an exchange-traded fund which seeks to provide the investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500 Index. The S&P 500 Index is a diversified large cap U.S. index that holds companies across all 11 GICS sectors, and as such may differ materially from the securities managed by Right Tail in client accounts. Benchmarks such as the S&P 500 Index and the SPY may be of limited use in understanding the risks and uncertainties inherent in the investment strategies managed by Right Tail. The information in this Review is not intended to provide, and should not be relied upon for, accounting, legal, or tax advice or investment recommendations. The Recipient should consult the Recipient’s own tax, legal, accounting, financial, or other advisers about the issues discussed herein. Nothing in this Review regarding tax strategies, tax savings, tax rates, tax efficiency, or any other statements related to taxes should be relied upon as an indication of Right Tail’s suitability to give advice or make decisions with respect to taxes in any jurisdiction. |
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
