87.5 F
San Fernando
Thursday, Dec 8, 2022
-Advertisement-

SPECIAL REPORT: The Silver in Service

Calabasas commercial real estate brokerage Marcus & Millichap Inc. is at the top of the Business Journal’s list of Most Profitable Companies – for the second year in a row. With a 40.2 percent rate of return on equity, averaged over three years, the brokerage firm leads the pack of heavyweights in the Valley region, outperforming larger companies such as Thousand Oaks biotech Amgen Inc., which had a return of 24 percent, and Burbank Walt Disney Co.’s return of 16.6 percent. Cherokee Inc., the Sherman Oaks-based apparel and home goods brands marketer, manager and licensor, garnered the second highest return on equity of 34.4 percent. Glendale-based DineEquity Inc., owner of restaurant chains Applebee’s Neighborhood Grill & Bar and IHOP, performed third best with a 24.2 percent return. Return on equity for public companies is essentially a company’s profitability expressed as a percent of its equity, or how much shareholders have invested. And while analysts say that return on equity is a fair way to compare profitability between companies in different industries, several corporate finance experts point out that some industry sectors tend to be more profitable because the types of costs to run those businesses are controllable. Service companies – like Marcus & Millichap, which makes revenue from its cut of real estate transactions that its brokers arrange – don’t make a product, so most of their costs, such as labor, are variable and can be changed as needed, said Craig Everett, assistant professor of finance for Pepperdine University’s Graziadio School of Business and Management. “Fixed costs don’t change, no matter what you do in sales,” Everett said. “Manufacturing – those types of companies are tied to fixed costs. So Amgen has huge fixed costs. But if it’s a service company, it’s all about expertise and labor. They can be very nimble, and up- and down-size quickly to accommodate up and down cycles.” M&M’s business model Marcus & Millichap was founded in 1971 but didn’t go public till October 2013. Competitors include L.A.-based CBRE Group Inc. and Chicago’s Jones Lang LaSalle Inc., both of which are public. Marcus & Millichap brokers sales of commercial properties, mainly apartments in the past, that sell for $10 million or less, although the company is pushing up-market. In the three short years since becoming a public company, Marcus & Millichap’s growth – and profits as well – have taken off, making it easy to see why it continues to lead the most profitable list. Since 2013, revenues have increased 58 percent, while net income has grown almost 710 percent. Last year, Marcus & Millichap generated net income of $66.4 million on revenue of $689 million. Compare that to its first year as a public company when net income was only $8.2 million on revenue of $436 million. In other words, during that span its profit margin (profits as a percent of sales) ballooned to 9.6 percent from less than 2 percent. “They’ve done an amazing job,” said Brandon Dobell, partner and analyst with William Blair & Co. in Chicago, Ill. who follows Marcus & Millichap. There are a few reasons why Marcus & Millichap has been able to grow its profitability so strongly, he said. For one, commercial real estate overall has been rebounding strongly since the Great Recession. The key factor, however, has been the company’s strategy to grow by number of employees. “Growing headcount from 7 or 8 percent on the low end to 15 percent on the high end – think about that as a driver for the business,” Dobell said. While growing its staff, Marcus & Millichap hasn’t really changed the costs of equipping or housing those new employees, he added. It’s kept rent, which is its second biggest cost after broker commissions, from increasing as quickly as sales. And growing by headcount takes almost no capital other than rent, desks and computers, the costs of which aren’t growing nearly as fast as Marcus & Millichap’s revenue, Dobell said. “Cash just builds and builds – while equity in the business hasn’t changed – that’s why returns are so high,” he explained. Another big factor is that the company paid down some debt with the stock it sold when it went public, but the company itself hasn’t sold more stock, and hasn’t had to raise capital to keep growing the business, according to Dobell. Compare that to Disney, he said, which has spent a lot of cash flow on operations, such as opening the $5 billion Shanghai Disney Resort last month. The challenge Marcus & Millichap is going to have to address soon is with shareholders who want to see some of that profit come back to them as dividends or acquisitions, Dobell said. Marcus & Millichap may have heard that message. Chief Executive Hessam Nadji said acquisitions may be on the horizon. “In addition to continuing its highly successful organic growth strategy, the company is also considering select strategic merger and acquisition opportunities,” Nadji wrote in a statement to the Business Journal. Nadji discussed factors that have helped increase profitability. Expanding market share in the company’s principal real estate category – real estate sales between $1 million and $10 million, is one. “This is a vast and fragmented marketplace and as the segment leader, Marcus & Millichap believes it still has ample opportunity to grow,” Nadji wrote. Second, growing its brokerage business beyond its traditional apartment market and into hospitality, self-storage and housing for seniors, lower-income individuals and students, Nadji said. It also launched the Institutional Property Advisors division, now five years old, to arrange real estate sales of higher value. “This is a supplementary strategy to the company’s core, private business and enhances its long-term agent and client value proposition,” Nadji wrote. Profitable diversification Cherokee, the second-most profitable local public company, makes money by licensing its trademarks to apparel manufacturers and retailers. Its brands are in more than 50 countries – compared to 19 five years ago – and 9,000 retailers. Its biggest customers include Target Corp. and Kohl’s Corp. Over the past three years, net income has grown 40 percent for Cherokee, although it hasn’t been steady. Its 2016 net income for the period ended Jan. 30 was $8.4 million on revenue of $34.7 million, down from $9.8 million on revenue of $35 million in 2015. Revenue has grown 21 percent. Chief Executive Henry Stupp said the company redefined its focus five years ago when he took over. He attributes Cherokee’s high profitability to growing organically, diversifying its revenue streams and geographical presence and using profitability defined by Generally Accepted Accounting Principles, rather than adjusted earnings that exempt certain events or conditions. Stupp chose to grow organically by increasing the presence of its own brands into other countries and by getting its brands into more retailers’ categories, rather than by acquiring brands. Many of Cherokee’s competitors have pursued expensive acquisitions to bolster top-line growth that never delivered the expected results, Stupp said, and some went into debt as a result. “We chose not to go that route,” he said. “I basically would say it’s about making sure your fundamentals are intact and you’re not solely focused on having to buy revenue.”

-Advertisement-

Featured Articles

-Advertisement-
-Advertisement-

Related Articles

-Advertisement-
-Advertisement-