(By Kevin Donovan) The commercial real estate market faces uncertainties aplenty, but HFF Inc. (HF), a small-cap financial middle man in the sector, is confident the transaction pipeline will swell. Its stock price should, too, in our view.
The stock can be volatile, sporting a beta of 2.58. Shares have traded between $7.83 and $16.93 in the past 52 weeks and are up 50% year to date, recovering after sharp fall on the heels of disappointment over second-quarter results.
Earnings per share were $0.29 in the second quarter, down 17% from the year-ago period, because, well, business was softer. The decrease in net income was primarily related to increased headcount and compensation-related costs, the company said. Still, production volumes for the second quarter were about $9.6 billion on 333 transactions, a decrease of 2.5%, on an increase of 2.5% in the number of transactions. The average transaction size was $29.0 million, down 4.9% from the second quarter of 2011.
For the third quarter, analysts estimate EPS of $0.28 vs. $0.29 a year ago on revenue of $67.88 million vs. $63.91 million. The company has missed estimates the last two quarters.
Nevertheless, HFF, which counts the likes of Blackstone and Morgan Stanley as clients, sees growth ahead, adding to its production payroll in anticipation of deals in the years ahead. The company increased employment by 80 in the past year to 541 as of June 30, an increase of 17.4%. The ranks of producers have swollen 20.9% during the same period to 214.
CEO John H. Pelusi Jr. said the employment increases were a "prudent investment" that position the company "to take advantage of future strategic opportunities as they arise, capture additional market share, and take advantage of the forecasted transaction volumes that are likely to arise from the more than $1.7 trillion of commercial real estate loans that are set to mature between now and 2017."
We think it's noteworthy that HFF is expanding while acknowledging the risks. Macroeconomic turmoil – from the Eurozone crisis to the looming "fiscal cliff" in the U.S. – has the potential to derail the capital markets.
"Generally speaking, the U.S. commercial real estate property level fundamentals, while continuing to improve in select major markets and in select property types such as multi-housing, remain soft, and they may also be vulnerable to what appears to be a slowing economy," Pelusi said last month.
But the company sees any slowdown affecting what it calls "secondary and tertiary markets." Primary markets in major metropolitan centers, HFF's chief focus, should remain relatively firm, the company believes.
At $15.51, HFF trades at forward PE of 12.31, a discount to the S&P 500. Placing a market multiple on next year's EPS estimate of $1.26 yields a share price of $17.75. We think HFF keeps gaining share in primary market and will warrant a premium to the market. On a price-to-free cash flow basis HFF is modestly valued with a multiple of about 12.
Meanwhile, the balance sheet remains strong with cash at $148 million at the end of the second quarter, an increase of $45 million from a year ago, providing a comfortable current ratio of 1.30.
Through its subsidiaries, Holliday Fenoglio Fowler, L.P. and HFF Securities L.P., HFF operates out of 21 offices nationwide, providing commercial real estate and capital markets services to the U.S. commercial real estate industry. HFF offers clients a fully integrated national capital markets platform including debt placement, investment sales, advisory services, equity placement, loan sales and commercial loan servicing.