"Buy what you know," goes the old saying. As a new homeowner, one company I know well is my home warranty provider, American Home Shield (AHS) -- a division of ServiceMaster (NYSE: SVM). Whenever the freezer stops freezing, the washer stops washing, or the garbage disposal stops disposing of garbage -- I give AHS a call.
That got me thinking of a quote from Tom Gardner in the market-beating Motley Fool Stock Advisor: "I covet high-quality subscription services. Why? The economics are terrific. It goes something like this: Become a member. Pay me now. Then I'll provide the service."
Those are exactly the kind of services ServiceMaster provides through its various divisions, such as AHS, Merry Maids, and Terminix, to name a few. ServiceMaster's customers pay a fee for an annual contract to fix their home appliances, get their houses cleaned weekly, or keep the termites at bay. The company pockets the money immediately, and then pays some of it out over the course of the annual contract to a network of contractors who fix problems as they arise.
Unfortunately, the company's 2003 earnings results, which came out last week, did not live up to the promise of a company with a stable of household names and a potentially great business model.
ServiceMaster's 2003 earnings from continuing operations were essentially flat over 2002, at $0.54 a share (before an impairment charge). Free cash flow was also lower for the year, falling from $314 million in 2002 to $244.3 million in 2003.
To make matters worse, accounting rules required ServiceMaster to take a $481 million pre-tax non-cash goodwill impairment charge to its GAAP earnings in 2003. So while the company's operating performance was flat, its earnings were actually negative. The impairment resulted in an after-tax earnings hit of $1.30 a share. As a result, the company was forced to report a $0.76 GAAP loss for the year.
But with the impairment charge behind it, ServiceMaster will probably return to profitability in 2004, growing revenue in the mid-single digits, with earnings per share growing slightly faster. If you run the numbers, ServiceMaster has an enterprise value-to-free cash flow ratio of about 15, and a P/E ratio of about 19.
Neither of these ratios is as pricey as the market at large, and as a bonus, ServiceMaster also pays a nice dividend of almost 4%. After a somewhat unfortunate year, then, ServiceMaster investors are being paid to wait for better times ahead.
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Rich Smith
is a contributor to The Motley Fool. He does not own shares of ServiceMaster.
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