Safestyle UK plc

The UK’s window and door replacements leader could be a 2X and 6X investment in 3 and 5 years, respectively!

Legal Disclaimer: This is NOT investment advice. Please be sure to do your own work. Seek advice from counsel regarding your financial, tax, legal, and/or other advisories. The author may hold Safestyle UK plc shares, and his views may or may not be biased.

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Safestyle UK plc is the UK’s leader in window and door replacements.

It has a market cap of GBP 24.6M and trades on the UK stock exchange FTSE AIM.

This company might be a true hidden gem, relatively uncovered by investment professionals. The company’s new management in place since 2018 has shown great ability and has done a superb job ensuring efficient operations management, showing sound capital allocation skills. I would not be surprised if Safestyle UK plc’s capitalization multiplies by 6X in 5 years.

Furthermore, should they decide to introduce a more efficient capital allocation process, replacing current guidelines, those 6X returns could turn out to be one of those “once in a lifetime” investments…

Below you will find 5 Questions (Asked and Answered) to provide you with a good overview of the company, covering the most important aspects. These Questions encapsulate a great summary of all the information I’ve been gathering on the company.

These questions cover the 5 topics outlined in this review:
1) The Company’s Business,
2) Moats and Advantages,
3) Alignment of Interests with Shareholders,
4) Valuation, and
5) Special considerations.

Let’s go!!

1)      What does the company do?

Source: Safestyle’s Capital Markets Day 2022 presentation, Safestyle logo

Safestyle is the UK’s largest supplier of replacement windows and doors to the UK homeowner market and is present nationwide. They control all aspects of the customer journey, from doors and windows manufacturing, to its installation. That said, all other points of contact with the customer are held by Safestyle namely; marketing, sales, surveying, as well as feedback loops.

The average age of their customers is 52, they are usually homeowners and normally their interactions result in a once- or twice-in-a-lifetime purchase. The reason for the purchase is mostly driven by energy costs, keeping out the cold and/or ensuring a higher level of security. Normally, the process of selecting the company and its products is an extended one, where consumers identify a small group of companies to consider. After this, the final key decision is based on price and trust (personal recommendations and reviews) factors.

In the UK there are close to 14.6 million households and approximately 800 thousand of them replace their windows and/or doors every year. This means that close to 5% of homes face this replacement annually. Another aspect to consider is that houses that aren’t repurposed, upgrade their windows and/or doors every 18 years, approximately.

The market is very fragmented, and they are the leader with close to an 8% market share (according to FENSA). They position themselves as the company that delivers the most value for the price paid. The other 2 big players are ’Everest’ (positioned as a premium windows and doors company) and ‘Anglian’ (mid-market, positioned between Safestyle and Everest), for a total circa holding of 15% market share divided among the top 3 players.

Source: Safestyle’s Capital Markets Day 2022 presentation

2)      Which competitive advantages and/or moats does the company have - if any?

There are some barriers to scale which the company has had to overcome some of which they continue to grapple with, in order to grow. The market being so fragmented, can be attributed to, in part, these barriers being so challenging for companies to overcome. Among these obstacles, I believe that there are some logistical complexities namely: escalating the business activity, costs of advertising at scale, and compliance scrutiny which is becoming more intense in recent times. Growth is always a challenge and at times companies falter when looking to expand into new territories and jurisdictions but, Safestyle UK has managed to scale their operations all while maintaining a high quality of customer service and ensuring they meet purchasers’ delivery expectations.

The previous explanation is important not only as an explanation of the current market structure but also because they help explain what I believe are the 2 most important moats: the intangible one of Brand Recognition/Reputation and Scalability (Cost Efficiency).

The company currently enjoys a good reputation (which leads to trust). In addition, they have a roadmap in place (explained on Capital Markets Day 2022) that I believe will lead to widening this moat for the next few years.

For instance, there is huge variability in the consistent delivery to customers across Safestyle’s network. The company has taken important steps to correct this gap, having established clear metrics and outlined clear steps to achieve that goal.

Also, they have created an academy for training staff which seems to be working well, with the additional benefit of it addressing an even greater market problem – a shortage of skills. Finally, the company has also established a role model depot from where all other sites can learn and copy the correct techniques, methods and procedures.

Scalability is the other source of moat. Some examples are as follows. They can run national marketing campaigns (currently running a TV Ad with David Seaman – the ex-goalkeeper for England), and the wider the network of sites (Sales branches and Installation Depots) the more Safestyle benefits (growth of sales) from brand and product awareness increasing.

A wider network also allows more customers to reach out to them from different locations (maybe due to family or friend referrals), and if they become happy purchasers, their reputation is reinforced. The company is currently opening new branches based on major population schemes, alignment with brand investment, fit capacity, depot proximity and mosaic and search trends data.

Source: Safestyle’s Annual Report & Accounts 2022

The main source of competition for Safestyle is local players. However, there are some key factors that altogether allow this market leader to have an advantage over their competitors.

They offer more finance options to windows and doors buyers. Once a customer has decided he/she wants Safestyle, they generally can install it faster than any other company. Safestyle always looks to win on price. Finally, they are able to offer a 10-year warranty that is very much appreciated by the homeowners.

3)      Are shareholders’ interests being safeguarded?

One of the key points I look for and love to see is when top management has over 10X their annual salary invested in the company’s value. This is certainly not the case here. Rob Neale, the current CEO, is far from that threshold, even taking into consideration the stock options he might receive. I would be delighted to see him increase his stake in the company, indicating he is truly confident in the value creation of the shareholders.

The top 3 shareholders (as of 9/5/2023, according to Safestyle’s website) are composed of Alantra Asset Management with a 22.98% stake, Soros Fund Management with 19.19% and Janus Henderson with 10.74%. These three shareholders make up 52.91% ownership of the company. I trust they will work as custodians for the remaining shareholders if needed. Holding greater than 40% ownership of a company like this is usually more than enough to exact control, meaning the supervision of the first 2 entities could be enough as they hold a 42% circa.

Finally, capital allocation deserves a word. The company has a framework where their order of priorities is as follows: Re-investment (ongoing capex and opex), Growth, Dividends (50% payout ratio) and finally, other returns to shareholders (Buybacks and special dividends). I would much rather prefer management not to follow this guideline but rather, to decide on the most efficient capital allocation at any point in time, i.e., allocate it where it creates the most value to the holders of the company.

  Source: Safestyle’s Capital Markets Day 2022 presentation

As market opportunities (e.g. M&A) have a higher priority than dividends on the previous framework, I trust management will not miss a very accreditive acquisition just to issue more dividends. Nonetheless, the buyback of shares only after paying dividends is something I do not like. Share buybacks can create a lot of value for shareholders if bought at a discount to the company’s estimated intrinsic value – the deeper the discount the better. Obviously, overpaying on share buy-backs destroys value.

Similarly, I like to mention two other aspects of it, as when in a discussion about dividends. If there is an investor who wants dividends, he can just sell his shares to keep his portion of ownership and get the money back. Dividends are also tax-inefficient to shareholders, there is double taxation: when the earnings are declared – at the corporate level – and when the dividends are received – at the personal level.

The point I want to make is, repeating the above: Capital allocation is to be done accordingly so as to create more value for shareholders. I believe Rob Neale, current CEO and ex-CFO of the company, could excel in this.

4)      How much could the company be worth? (Valuation)

On Capital Markets Day (CMD) 2022, the company established the following mid-term targets (defined by them as 3 to 5 years):

• GBP 200m Revenue

• 34% Gross Margin

• 10% PBT (Profit Before Tax)

• GBP 22.5m Operating Cashflow.

It is important to note that this would mean an increase of +5% CAGR in Revenue from FY 2022 to FY2027, and the return to operating margins before 2016 (More on Safestyle story in the next session – Stay Tuned!). The roadmap provided on CMD as well as how they excelled in their execution over the past several years, gives me confidence that these numbers are attainable and could even be exceeded.

Source: Safestyle’s Capital Markets Day 2022 presentation; roadmap to the 10% PBT

Predictions based on the numbers

Assuming Revenue grows as expected until GBP200m and margins keep on improving until 2027 – defining the mid-term as the 5-year period (in the next Q&A I will discuss the possible recession and inflation impacts).

In 2025 (3 years’ time), the company could be making GBP 5m in Earnings and in 2027 could be around GBP15m; the market capitalization of the company today is (29/6/2023) around GBP 24.6m (price of GBP 0.1770). This means the company would have a Price/ Earnings of 4.92X and 1.64X in 2025 and 2027, respectively.

Assuming a conservative P/E for the UK’s industry leader with moats of 10X earnings, an investment today would lead to +103% (doubling, 27% CAGR) gain on the share price, and +510% (83% CAGR) in 5 years. All of this, excluding the dividends received by shareholders in the meantime; and possibly accretive M&A and share buybacks, as well as new product launches that would foster growth (optionality), among others.

5)      Any other special considerations to mention?

The last 5-10 years have been all but easy for Safestyle. Former employees of Safestyle decided to part ways with the company to create and work for a new company selling under the name of SafeGlaze and applying some doubtful practices (starting with the name similarity). To face that situation a new management team was formed in 2018 – headed by the CEO Mike Gallacher (joined in May) and Rob Neale as CFO (since July) – they designed a turnaround plan. During that period SafeStyle demanded and won the battle in court against SafeGlaze (in 2018), and the company was finally dissolved at the beginning of 2020.

Covid came just after that, with the famous lockdowns. Inflation was at unprecedented levels, there were labour shortages, and supply disruptions, among others.  Finally, after a strong 2021, the company was heading into 2022 with high hopes, only to suffer a Russian cyberattack in January 2022.

Source: Safestyle’s Capital Markets Day 2022 presentation

During all these extreme events the new management (in place since 2018) operationally excelled. The cherry on the top came in November 2022 during Capital Markets Day (CMD) where they presented the mid-term strategic roadmap.

CMD 2022, has shown that every employee has been given a clear path to follow. They all know which steps are needed to achieve the company’s projected goals. I am confident that Safestyle will return to previously achieved profitability margins (I wouldn’t be surprised if they surpassed them in the long run) as well as enjoy a stronger position in the market as their moats widen (i.e., more consistent and improved service, increased reputation, trust growth, and a wider network). I recommend to anyone interested in this company to have a look at their CMD presentation. You can find it here.

Given the current macro situation, I would like to briefly touch on the possibility of a recession and the impact of inflation on the business. Regarding the former, it is worth noting that, as stated previously, purchase is driven primarily by necessity plus Safestyle is positioned as a value solution (low price), which is attractive to budget-minded investors. They also offer a solution for energy bills. And they have done well in past financial crises. Regarding the latter, they have been able to pass on prices to consumers, with exceptions being the Russian cyberattack and the corresponding recovery period, where they could not keep up to date with their pricing. All that being said, both recession and inflation could potentially work in their favour because in both instances Safestyle UK stands to increase their market share due to its product’s value proposition (low-end prices).

Finally, there are some optionalities that were not included in my valuation of Safestyle but make it even more attractive:

• The company is currently researching the viability of creating a premium brand. Management believes the high-end premium and value-end low-cost options are the best places in the market to be. In addition, they also happen to only be using 40% of their factory in Yorkshire, which is rated as the best inventory factory in the country.

• The already launched “beam”, a product that offers buyers the opportunity to design and buy doors online – hopefully, they will add the possibility to buy windows online too. This new segment can give around 13-14% Profit Before Taxes, so better margins than the traditional business. Just launched in 2022, if executed well it can be the cause of big market share gains.

• Lastly, the company has spoken about the possibility of a few mergers and potential acquisitions, which given current market fragmentation would make a lot of sense.

Mike Gallacher, CEO of the company since 2018 and the captain navigating the aforementioned turbulent times, has stepped down from his role in December 2022. He was substituted by Rob Neale who was formally Safestyle’s CFO. It is certainly good news that the new CEO is someone who was present during the whole Group transformation process. Phil Joyner, who also joined the company in 2018 as Group Financial Controller was promoted to CFO. It is worth mentioning that Safestyle was the second turnaround of Mike in a short period of time, as he was pointed CEO of First Milk in 2015, and in both cases, he did a terrific job.

In a nutshell. Safestyle UK plc, which is the market leader with close to 8%, operates a resilient business, prepared for inflation and recession. The high market fragmentation presents an opportunity for consolidation. Management has excelled operationally. There are some risks and uncertainties namely the execution of the strategic roadmap presented on the CMD 2022 and a new leader (Rob) that is just starting a new role.

If things go as planned, the company could be worth 2x more in 3 years (2025) and 6X in 5 years.

My most pressing negatives are the level of ownership management has in the company (I would love to see them increasing it), and the capital allocation framework. Instead of using a fixed one, it would be much better if they decided according to the most efficient uses of cash at any point in time – i.e. to maximize earnings per share. And then, who knows, Safestyle could become a wonderful compounder, one of those “once in a lifetime” investments…

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