MEA's an interesting study in deep value

A few thoughts on MEA. I’ve been scratching my head about the recent sell-off. Obviously geopolitics combined with a lack of liquidity are playing a big part, but at these levels it’s too cheap to resist even with uncertainty plaguing global markets. We still all need somewhere to live, and we move house from time to time. McGrath is one of the best in the business, and consumer demand for their services will always exist.

I had a bit of rant in my last post about management not being able to achieve any organic growth in the last half, and spending shareholders’ money on seemingly speculative investments. I also suspect head office costs could be shaved substantially. So, I have ongoing concerns about management, but then I need to remind myself that we're not at the Wesfarmers end of the market here, and we're not paying 25 x earnings!

MEA has circa $40m in cash in the bank (recent spending on Honey deal and dividend should have been just about replenished by now). At the recent share price low of 45.5c ($75m market cap) the underlying business is valued at $35m. That’s less than 2 x current cash flow. Ok perhaps current earnings aren’t sustainable (although I note Sydney sales volumes through 2022 are still up 30-40% on same time last year – so there’s still a bit of life left in this boom). But to be really conservative let’s pick a sustainable cash flow figure of half current levels of $20m (i.e. $10m). $10m is about what MEA was earning pre-float in 2014 and 2015 (back when mortgage interest rates were at 5%!) on revenue of only $75-$85m. So at 45.5 cents a share even if cash flow falls 50% to $10m, we’re still only talking 3.5 x ebit for the EV. That’s what you pay to buy a small business (which, once you buy it, you have to manage!)

Or look at the valuation another way – MEA’s company-owned rent roll is worth $50m. Rent rolls are rock solid assets and MEA’s could be sold tomorrow for $50m. So just the rent roll plus cash = $90m = 54c a share. That’s before you put any value on the bulk of the business – i.e. the company-owned agency business, the franchise agency business, and the franchise rent roll.

If there are any mid-market PE firms out there reading, MEA would be such a no brainer - the market doesn't seem to like it much but it spits out cash. No doubt MEA itself will be buying every share it can get its hands on at these levels when the buyback kicks off in a week or two.

Will be interesting to watch this play out.