Upslope Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. The Fund returned 7.5% net of fees for the third quarter, as compared to the 4.7% return of the S&P Midcap 400 ETF and 3.6% return of the HFRX Equity Hedge Index. You should check out Upslope Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Upslope Capital highlighted a few stocks and Bright Horizons Family Solutions Inc. (NYSE:BFAM) is one of them. Bright Horizons Family Solutions Inc. (NYSE:BFAM) is a United States–based child-care provider. Year-to-date, Bright Horizons Family Solutions Inc. (NYSE:BFAM) stock gained 9.2% and on October 21st it had a closing price of $165.75. Here is what Upslope Capital said:
“Bright Horizons is a leading operator of daycare centers and related services, primarily in the United States and, to a lesser extent, the U.K. and Netherlands. Offerings include full-service daycare (~85% of revenues in a normal year), back-up care (on-site or home-based for both children and the elderly; ~10% of revenues), and education advisory (~5% of revenue).
What makes Bright Horizons unique is its employer-sponsored offering (e.g. on-site daycare center operated for the benefit of a company’s employees. The employer covers capex and facility maintenance). This focus results in a stickier customer base (95%+ retention7 ), lower capital needs, and the opportunity to compete more on quality of service than price. Within this attractive niche, BFAM is 6x as large as its next biggest competitor.
While BFAM’s earnings were hit hard due to COVID-19 shutdowns, the company’s competitive position has likely been strengthened, relative to smaller competitors, as a result of the crisis. Further details on the thesis are below:
1) Definition of an essential business. The essential nature of BFAM’s business, combined with its industry-leading scale (and thus durability) is what initially attracted us to the company. Simply put, the economy cannot fully re-open without daycare providers also being open. “Work from home” – whether it’s here to stay or not – is not a serious threat to the business model or demand over the long-run (I dare you to try to be productive “working from home” while simultaneously watching a toddler or two full-time).
2) Clear competitive advantages, likely enhanced by the pandemic. In the highly-fragmented childcare services industry, sticky employer-customer relationships, as well as industry-leading scale and a trusted brand are all key competitive advantages for Bright Horizons. Ultimately, the company seems far better equipped to navigate pandemic-driven changes and adversity relative to smaller-scale competitors – leaving ample room for and possibly accelerating growth and consolidation.
3) Attractive financial model. Over the last 10 years, BFAM has generally grown revenue in the 8- 10% range, while experiencing modest operating leverage and delivering strong free cash flow (free cash margin has expanded notably). While there will be at least a temporary margin reset due to COVID-19, there is no reason to believe that margins can’t ultimately continue to expand over the long-term, as the business grows.
4) Low cyclicality. During a “normal” recession (i.e. one not triggered by a pandemic and related shutdowns), BFAM could be considered a business with low cyclicality due to the essential nature of its services. The company grew revenues during the financial crisis, despite decent exposure to financial services sector employers. Today, BFAM has a highly diverse customer base, with Healthcare & Pharma as its largest industry exposure (30% of 2019 sales, followed by Financial Services at 16%).
5) Institutional backstop. Given Bright Horizons’ low cyclicality, predictable cash flows and leading competitive position within a fragmented industry, it seems logical to assume that private equity would be quite interested in the business should it face challenges again. Supportive of this assumption is the fact that BFAM (A) was previously owned by private equity (2008-13) and (B) easily raised $250mm of new equity from a respected institution during the height of pandemic.
6) Key Risks. (A) relatively full balance sheet (~4x net leverage based on depressed 2020 consensus earnings – closer to ~2x normalized), (B) margin headwinds likely to persist over the short-and medium-term due to COVID-19-related capacity constraints, and (C) modest macro/cyclical exposure, given employer-sponsor connection.”
In Q2 2020, the number of bullish hedge fund positions on Bright Horizons Family Solutions Inc. (NYSE:BFAM) stock increased by about 11% from the previous quarter (see the chart here), so a number of other hedge fund managers believe in BFAM’s growth potential. Our calculations showed that Bright Horizons Family Solutions Inc. (NYSE:BFAM) isn’t ranked among the 30 most popular stocks among hedge funds.
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Video: Top 5 Stocks Among Hedge Funds
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Disclosure: None. This article is originally published at Insider Monkey.