Faced with finding three top franchise stocks to buy for 2024 and beyond, I want to keep the restaurant names to a minimum. That’s especially true, given I’ve only got three spots available. I’ve got to be extra diligent.
Franchise Direct’s website ranking the top 100 franchises for 2023 has several names I recognize as public companies. Many of them aren’t restaurant operators. This should make my task a little easier.
However, an excellent way to find franchise companies is to use the Securities & Exchange Commission’s Edgar advanced search tool that searches through SEC filings. You tick off 10-K in the “Browse filing types” section while entering the word “franchising” in the keyword section. When I do that, I get 226 results from the past year.
Based on these two screening methods, here are my three top franchise stocks for the remainder of 2023.
Of the three names on this list, FirstService (NASDAQ:FSV) is the one I’m most enthusiastic about (and not just because it’s based in my hometown of Toronto).
I have been keen on FirstService since October 2020, when I included it in a group of 10 Canadian stocks to buy. One of the reasons I liked the company was that, despite its Canadian location, it generated 90% of its revenue in the U.S. Operating two segments, FirstService Residential and FirstService Brands. It is the latter that utilizes franchising to grow its business, and accounts for 57% of the company’s revenue. The former is the largest provider of residential community and amenity management services in the U.S. and Canada. It accounts for 43% of FirstService’s $4.1 billion trailing 12-month revenue.
FirstService Brands has more than 1,500 franchisees and company-owned locations generating $4.2 billion in system-wide sales, which translates to $2.0 billion in revenue for the company. Approximately $200 million of that is franchise/royalty-based.
The company’s property restoration business consists of First Onsite (80% commercial) and Paul Davis (80% residential). Together, they generate $2.0 billion of the segment’s system-wide sales from 450 branches in the U.S. and Canada. Given the U.S. restoration market is estimated at $60 billion annually, the potential for growth is enormous.
So, you get the best of both worlds with company-owned and franchised locations. In the first six months of 2023, FirstService’s adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) were $200.4 million, 30% higher than a year earlier. This company is very profitable and growing.
European Wax Center (EWCZ)
EWCZ went public in August 2021, selling 10.6 million shares at $16. It used the net proceeds to buy units of EWC Ventures, the operating subsidiary of European Wax Center.
When the company went public, it had 808 locations operating in 44 states. Of those, 803 were franchised. As of July 1, it had 1003 locations in 45 states, with 997 franchised. In fiscal 2023, it expects to open between 95 and 100 net new locations.
In 2023, it expects system-wide sales of at least $965 million, total sales of $222 million and adjusted EBITDA of $77 million.
On two occasions, EWCZ shares traded around $32 — October 2021 and March 2022 — before falling back into the teens. In the second instance, shares dropped by 62% to an all-time low of $12.02 in December 2022.
Volatile, it is.
The biggest concern with this business is its net debt. It’s very high. As of July 1, it was $380 million, or 37% of its current market cap. More importantly, it increased its operating income in the first six months of the year by nearly 19% over last year. However, its interest expense increased by 42%, reducing the pre-tax growth to 11% year-over-year.
Its current enterprise value of $1.15 billion is 14.9x its projected adjusted EBITDA, cheaper than it’s been since going public in 2021.
Latham Group (SWIM)
This last one is the riskiest of the bunch. Trading in penny-stock territory, the Latham Group’s (NASDAQ:SWIM) stock symbol tells you everything you need to know about its business. The company is the “largest designer, manufacturer and marketer of in-ground residential swimming pools in North America, Australia and New Zealand,” according to its investor relations website.
The August presentation states it is “The only pool company that has established a direct relationship with the homeowner.” That’s because it operates a direct-to-homeowner business model that provides customers with a coast-to-coast manufacturing and distribution platform, essential to the success of any direct-to-consumer business.
Latham’s presentation also says it’s grown its sales and adjusted EBITDA for 13 consecutive years.
So, why is it trading at less than $3?
If you don’t already have a pool, you can always pass when things get tight. Higher interest rates have made things tight.
As a result, Latham’s sales in the first six months of 2023 are down 21.0% to $314.8 million with a 13.3% adjusted EBITDA margin.
So, why buy?
Latham went public in April 2021 at $19 a share. Its shares got as high as $31 a month after its IPO. It’s been downhill ever since. When it went public, it had a 20.8% adjusted EBITDA margin. In the four years before that, it never fell below 15.8%. In 2022, it was 22.2%.
When interest rates return to normal — and it may take several years — SWIM will be trading for more than $3.
It will take a boatload of courage to buy this stock. The risk/reward proposition for aggressive investors is stacked in your favor.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.