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FrontDoor: Assessing the Growth Opportunity

- By Nicholas Kitonyi

The U.S. stock market has experienced one of the sharpest declines in recent years following the October-December 2018 plunge that saw all the major indices tumble.

This meltdown has greatly contributed to the decline in stock prices of several companies to the point that it has been difficult to point out individual challenges in some of the stocks affected. FrontDoor Inc. (FTDR) has suffered from the same market-wide plunge but, its story has a lot more going on than just the impact of the current bear market.

The company's stock price declined sharply at the start of November when it announced its first results (the third quarter) since its spinoff from ServiceMaster Global Holdings (SERV) in mid-September. FrontDoor's third-quarter earnings impressed on the top line but disappointed on the bottom line, and worse, management issued weak guidance on gross profit for the next quarter.

However, FrontDoor stock has since held steady and looks to be on the way up, albeit gradually, to recoup some of the losses. The company's stock currently trades around the $28.00 per share level, but most sell-side analysts remain bullish with a strong outlook and a price target of $40.00 and above.


FrontDoor's market-leading business

FrontDoor operates in the home services business, offering services that range from home improvement, repairs and maintenance. The company focuses on taking the hassle out of home ownership through its vast network of services. This business presents one of the biggest investment opportunities in the U.S. considering that just under 4% of all Americans have a home service plan in place.

The overall addressable Home Service market is potentially worth more than $400 billion according to market analyst reports. These reports also point out that the home service warranty segment that is greatly underpenetrated was worth about $2.53 billion over a year ago. So, there is a lot of room for growth.

Currently, FrontDoor controls 46% of the market with its closest rival First American, accounting for about 11% of the annual sales. This gives the company an edge when it comes to contract negotiations with suppliers, thereby boosting its potential to increase profit margins.

The company has also expanded its service offering over the years by making key acquisitions and strategic partnerships that have helped it to diversify. FrontDoor is the parent company to some of the leading brands in the home warranty business market, with the likes of HSA, OneGuard, Landmark and American Home Shield among those in its portfolio.

Some of these brands command a massive client base, which is what has given FrontDoor the market leading moat against its rivals. For instance, American Home Shield, the largest home warranty brand in the country, commands a client base of about 2 million customers who are subscribed to at least one of its home servicing plans.

Given that the total number of home service plan subscribers in the U.S. is just knocking towards 4.5 million (less than 4%), this implies that there is a massive opportunity for the industry to grow.

Why this market is poised for growth

When you look at the current industry trends that seem to be shifting towards automation, advanced home systems will become critical to every home. The "smart home" phenomenon does not stop with smart curtains or Amazon (AMZN) Echo. Ventilation and heating systems are now part of the smart home, as are sewerage and irrigation systems.

The more systems a home has installed, the higher the chances of malfunctions, breakdowns, and wear and tear. This means that more homes will be forced to do repairs and servicing more frequently than before. As such, it will make a lot of sense to prospective clients to purchase home servicing and warranty plans.

FrontDoor, through its vast network of brands that include American Home Shield, has established a strong relationship with most of the service providers in the industry. Therefore, it looks like the company could reap the benefits of its huge business moat in the coming years.

Are investors reading too much into the company's recent quarter results?

In the most recent quarter following the spinoff from ServiceMaster, FrontDoor reported earnings per share of 58 cents, which missed analyst estimates of 68 cents per share. However, it beat Street estimates on the top line by $7 million after posting sales of $377 million compared to the consensus estimate of $370 million.

But more telling was the fact that despite posting top-line growth of about 9%, profits did not improve. The Ebitda, gross profit and net profit for the period all declined. The company's management pointed to a sharp increase in claims as the reason why gross profit dropped to 47% from 52% year-over-year.

Furthermore, FrontDoor went on to issue weak guidance for gross margins, saying that it now expects about 43-44% through 2018. This is despite slightly raising estimates on projected sales for the year to $1.25 billion.


Investors appear to have read too much into the weak guidance on margins, which could imply weaker-than-expected bottom line for the year.

However, FrontDoor's growth prospects following the spinoff off of its parent ServiceMaster look better now that it is flexible enough to invest in projects that are more aligned to specific goals. It currently has more than $104 million in free cash flow, which could come in handy when it begins to assess potential projects to invest in.


In summary, FrontDoor post-spinoff performance has not been great. The company's stock price has suffered from a multitude of factors. While some of those factors, which include weak guidance on gross margins, shrinking profits and potentially post-spinoff shocks, have played a role, the general market-wide plunge during the fourth quarter of the year 2018 cannot be ignored. As such, FrontDoor looks like a good candidate for one of the most impressive growth stocks that investors could invest in while on the dip.

Disclosure: I have no positions in the stocks mentioned.

This article first appeared on GuruFocus.