Business Breakdowns
· Zack Fuss
[00:00:00] S0: We'll come back to kind of the ebbs and flows of Roto-Rooter's businesses and its different services, but how about a similar overview of kind of the VITAS business and how it came to be?
· Chadd Garcia
[00:00:00] S1: One quick note. If you look at Roto-Rooter's history, they have grown their revenue about 6% clip. That's about standard for them in a 2-3% normal inflation environment. And then because they've been expanding their margins, they have about 25% EBITDA margins. But because their margins have been expanding, their earnings growth has grown about 12%. VITAS. We'll get into that business, but it has about the same profile with respect to low-mid single-digit revenue growth, low double-digit earnings growth. And then when you combine it at a corporate level and you layer in all the share repurchases they have, their EPS grows about 20-21% and their stock price over the last 21 years has compounded about the same rate. VITAS is a hospice and palliative care provider. What hospice care does is it provides health care to patients who are in their final days of their life. When you're in your final days, you have a couple courses of action with respect to healthcare. You can continue to try to receive curative care, which is quite expensive and oftentimes ineffective. It may actually do more harm than good. Or you can opt for palliative care which aims to manage your pain and make it more comfortable on your final days. VITAS provides that and it's provided 99% of all the care is provided in a patient's home. If you're in your final days, one can imagine that it would be more comfortable for you to be in your own house as opposed to a hospital. Hospice providers enable that to happen.
· Zack Fuss
[00:00:00] S0: Now that we have a good summary of the two businesses, I'd love to do a deep dive into Roto-Rooter itself. Why is this a good business? Why is it defensible? What enables them to earn the returns on capital they do, which by your math are incredibly impressive? Just kind of explain the nature of these plumbing services businesses and why the Roto-Rooter brand bestows such an advantage onto their franchisees, independent contractors and company-owned branches.
· Chadd Garcia
[00:00:00] S1: Well, I think Roto-Rooter is the gold standard for emergency plumbing service. If your drain is clogged, Roto-Rooter can be top of mind. About 70-75% of their service calls typically are emergency care or same-day of service. If you're at home and your sink's clogged and your family has dinner to make, you don't want to wait around for several days to fix a problem. You call Roto-Rooter and they can be out the same day and they fix it. And people are generally price insensitive to that. Roto-Rooter's revenue is driven by population and new business and new household formation. So that's going to drive the top line. Other than that, it's about how quickly you can get out to somebody's house or business and provide the service that they need. If you look at how that has worked out for them, they provide pretty good quarterly data on each of these business going back to 2012. And Roto-Rooter's had up until recently maybe three quarters between 2012 and 2023 where they had negative growth. The acyclical nature is pretty evident. Recently they have had some problems and I think the problems are a fewfold. They started in the first quarter of 2023 with some negative comps and those problems have persisted a bit. But when COVID hit, as you can imagine, their commercial revenue was impaired because restaurants and businesses closed down. Hospitals locked people out. But given work from home, there was a massive pull-forward in demand and a massive new demand because people were using their homes more. And if you use it more things break and drains get clogged. Roto-Rooter was a huge COVID beneficiary. I think that there was a fair amount of demand pull-forward as people may have replaced faucets or other plumbing fixtures that they have tolerated for years. But when you're around it every day, you want to get it fixed. The inflation that happened post-COVID may have given some people some incentive to instead of hiring Roto-Rooter to replace a garbage disposal, maybe learned how to do it themselves. So there may be some of that going on as well. In the recent years, private equity has emerged as a formidable competitor. That started to be felt in 2021, although Roto-Rooter did quite well, benefiting from the initial post-COVID work-from-home boost. But they started to see private equity starting to hire some of their general managers away in 2021.
· Chadd Garcia, Zack Fuss
And then recently, we've seen the competitors get pretty savvy with respect to some of their search engine optimization and marketing. [00:00:00] S0: Broadly, if I consider local plumbing and services businesses, what are the barriers to entry and why are there structural advantages for Roto-Rooter versus the private equity upstarts?
· Chadd Garcia
[00:00:00] S1: As I said, the emergency care is 70 to 75% of their services. That is ticking up a bit. The CFO didn't disclose what it was, but he says it's higher. That shows me that Roto-Rooter has some brand relevance with respect to emergency services. But both the private equity players and Roto-Rooter should benefit against mom-and-pops. Roto-Rooter in plumbing overall probably has a 2 to 3% market share. In drain cleaning, they probably have a 15% market share. The larger players can be more savvy with respect to search engine optimization and marketing and beat out a lot of the smaller local businesses. With respect to how Roto-Rooter is going to compete against the private equity players, I think Roto-Rooter has been at it for a lot longer. They've learned from their mistakes. There are two private equity players that they've been running into a lot. One is called Apex, which is backed by Alpine Investors. One's called Ben Franklin, which is owned by Authority Brands. Some of these players are combining the roll-up of plumbing businesses with other home service businesses such as HVAC. Roto-Rooter tried rolling up HVAC in the 90s. It didn't really work out well for them. They're not really too bullish on this working out for private equity players. In '21, the private equity players picked off about 20% of the general managers of Roto-Rooter. They did go after Roto-Rooter's employees. And with hiring away the general managers, that also took down the next level of management beneath them. Because those general managers took people with them to the new firms. Within a year and a half, two years, half of the general managers had returned to Roto-Rooter. I think that there'll be a benefit to Roto-Rooter as being an owner in this business as opposed to a renter. I think the general managers that left and came back may have learned that the grass isn't greener on the other side all the time.