|Shares Out. (in M):||86||P/E||0||0|
|Market Cap (in $M):||3,857||P/FCF||14||0|
|Net Debt (in $M):||1,552||EBIT||0||0|
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CoreLogic (CLGX) is a high quality data/information company serving the housing and mortgage industry. Its proprietary, contributed and public data is used by financial service, insurance and real estate clients to manage their own businesses (underwriting, risk management, compliance, etc.). CLGX operates two segments: Property Intelligence and Risk Management and Work Flow. The company was separated from First American Financial (FAF) in 2010.
From the 10K:
“Our databases include over 904 million historical property transactions, over 100 million mortgage applications and property-specific data covering approximately 99% of U.S. residential properties, as well as commercial locations, totaling nearly 150 million records. We are also the industry's first parcel-based geocoder and have developed a proprietary parcel database covering more than 140 million parcels across the U.S.”
CLGX has been written up twice on VIC: Francisco432 in 2010 and jso1123 in 2013. I suggest those write ups for background on the company. I’ll focus this write up on what has changed in the past few years (notably a new management team, M&A and end market) and why I believe CLGX represents a compelling long investment.
CLGX is trading at 14x 2017 FCF on depressed margins. I believe this is attractive on an absolute basis given CLGX’s fundamentals and relative to the S&P / its peers. The stock should re-rate as the company delivers revenue growth in a more stable mortgage origination market and margin expansion due to cost cutting, op. leverage and an improved business mix. Downside should be manageable based on the company’s free cash flow generation.
Business Quality: CLGX has 45%+ gross margins, a dominant competitive position and generates substantial free cash flow (55-60% FCF/EBITDA). Its customers highlight a strong value proposition and note high switching costs.
Margin Expansion: CLGX is targeting expansion from 25% in 2017 (implied EBITDA margin based on guidance) to 30% run rate exiting 2019. This was reiterated on the Q2 2017 conference call.
Attractive Valuation: 14x 2017 FCF on depressed margins and stabilizing end market cycle. This is based on $3 FCF/shr in 2017 compared to $3.75 FCF/shr in 2016.
Why does this opportunity exist?
CLGX’s valuation reflects three key overhangs/headwinds: a declining mortgage origination end market (due to refi activity), depressed margins due to negative operating leverage and its VSG initiatives and uncertain organic growth. As these overhangs lessen in the next 2-3 years, CLGX’s valuation should re-rate higher to reflect a more stable and profitable business.
CLGX has a dominant competitive position, earns a mid to high 40% gross margin and generates a return on tangible capital north of 20%. Based on industry checks, it would be very costly and time consuming to recreate the company’s data/information assets. Many customers also note CLGX is a “best in class” provider. This is important for a highly regulated and scrutinized industry such as housing. As a result, CLGX has been gaining market share as customers are increasingly focused on regulatory compliance and find it more economical to leverage scale providers. This should increase CLGX’s competitive advantage over time as it is able to further invest in the business and grow wallet share with customers. As an example, one customer recently indicated substituting out CLGX would require many vendors and make oversight increasingly difficult. This is also creating a pricing opportunity for the company. CLGX has said on the last few calls it expects pricing to be a more meaningful contributor to revenue growth going forward.
“There wasn't a lot of price in our growth. It was more of a share gain strategy than a price strategy. And so now that's shifting to more of a pricing. So if you look at go-forward underlying growth, I think you're going to get a couple percentage of points, percentage point or two out of pricing.” – Stephens conference, 6/7/17
CLGX generates substantial free cash flow. FCF / EBITDA has been 55% plus since 2012. This is higher than most information service peers. CLGX has used its free cash flow for buybacks and bolt-on M&A. The company has returned $1.1 bn to shareholders since 2011. This is significant considering CLGX’s $3.8 bn market cap. Bolt-on M&A has been used to address customer pain points in adjacent markets (largely in the insurance, data/analytics and appraisal areas).
“Since 2011, we have returned $1.1 billion to our owners through our ongoing share repurchase program.” – Q2 2017 call
CLGX has a relatively new management team. Frank Martell was appointed CEO in March 2017. He was previously COO and CFO. Industry checks have been positive. He has a track record of disciplined execution and a strong focus on cost management (technology, facilities, back office, etc.). The company has targeted around $20-30 mm of cost savings per year over the last several years (~100 bps). This likely continues. Jim Balas was appointed CFO in April 2016.
CLGX’s EBITDA margins should bottom in 2017 and then rebound over the next 2-3 years. The key levers will be operating leverage, business mix and cost reductions. CLGX is guiding to a 25% EBITDA margin in 2017 and is targeting a 30% EBITDA margin in 2019 (run rate exiting).
“We remain committed to achieving 30% plus adjusted EBITDA margins over the next three years based on a normalized U.S. mortgage market and accounting for the build-out of our valuation solutions platform.” – Q2 2017 call
The margin decline in 2017 is largely driven by two factors. First, mortgage originations are down. 60% of CLGX’s business is tied to mortgage originations and this is creating some negative operating leverage. Second, the company is growing its Valuation Solutions Group (VSG) business and this has been dilutive. CLGX’s Property Intelligence segment (houses the VSG business) was earning a low 30% EBITDA margin before VSG (mid-2015). It has since declined to the low to mid 20% range with the inclusion of VSG. The company is focused on improving VSG’s margin over the next 2-3 years through increased automation, business mix and scale. It is also probable these acquired businesses were not run efficiently. The platform businesses within VSG (FNC / Mercury) have ~50% EBITDA margins. The appraisal management company (AMC) business within VSG is underearning but should improve. A well-run AMC can have a mid-teens EBITDA margin. Management is targeting a mid-20% EBITDA margin for VSG in total. It reached close to 20% in Q2 2017 without the benefit of Mercury. The margin improvement in VSG, modest operating leverage from a stabilizing end market and continued cost reductions ($20-30 mm p.a.) make a bridge to the 30% EBITDA margin target reasonable. The company is using a $1.5-1.7 trillion origination market as its base case.
“We're basing it on kind of a $1.5 trillion to $1.7 trillion market.” – Stephens conference, 6/7/17
CLGX is trading at 14x 2017 FCF. This is cheap relative to peers, the market and its fundamentals. There is not a perfect peer given business mix but competitors listed in the 10K trade north of 20-25x FCF. CLGX will not trade here given its cyclicality and lower organic growth but 14x on what could be a trough year seems too cheap. As noted above, 2017 should be a bottom for CLGX’s EBITDA margin. The large step down in mortgage originations is happening in 2017 due to a 40% decline in refinance activity. The MBA is forecasting a flat to modestly rising origination market through 2019. The transition to a purchase driven market should be helpful for CLGX and its customers. Importantly, it should be supportive of CLGX’s MSD organic revenue growth framework. Management estimated 4% organic growth in Q2 2017. Total revenue declined 5% in Q2 2017 based on a market that declined 15%. Admittedly, it is hard to tie exactly to management’s organic estimate but a more stable market going forward should make that easier.
“We believe a return of the U.S. mortgage market to a purchase-driven foundation is good news for CoreLogic and for
the industry as a whole. The end of the refinancing boom of the last five years, although challenging this year, sets the stage for a more predictable and sustainable growth pattern in U.S. mortgage volumes in the years ahead.” – Q2 2017 call
CLGX should be able to generate nearly $4 per share of FCF in 2019. This assumes 3.5-4.5% rev growth in 2018/2019, a 28.5% EBITDA (vs. 30%), a 57.5% FCF conversion (midpoint of management range) and modest buybacks. The company has aggressively reduced its share count since 2010. If one uses a 15x to 17x multiple, it implies a $60 to $68 range. I believe downside should be manageable given CLGX’s free cash flow generation and modest sell side expectations (i.e. minimal margin improvement). Based on Bloomberg, sell side is modeling a 26% EBITDA margin in 2018/2019.
“In terms of the cash flow, we have talked about being in that 55% to 60% range.” – Q2 2017 call
There are a couple clear risks. The first is macro/higher rates further pressuring mortgage originations. The offset is purchase originations are less dependent on mortgage rates than refinance originations. Refi is forecasted to be ~$500 bn in 2017 and $400 bn in 2018 versus $500 bn to $1.5 trillion over the last several years. Purchase decisions are generally driven by demographics (population, household formation, etc.). This should be a tailwind going forward. The other risk is execution on its VSG growth initiative. The company is making progress diversifying its revenue away from BAC and WFC and improving margins but there is still a lot of required execution. I believe this risk is partially mitigated by CLGX’s valuation. I also think Frank Martell has executed well on acquisitions and divestitures/wind downs of non-core businesses over the last several years and VSG is a key focus.
These are my own views and subject to change without notice.
1. Organic revenue growth.
2. Margin improvement.
3. VSG new business wins.
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