FIX - Comfort Systems USA: The Run Continues

2023-11-28 18:27:16 ET

Summary

• Comfort Systems USA, Inc. has seen continued growth in sales and margin expansion, leading to a 40% increase in share price.
• The company has engaged in bolt-on acquisitions to add to its sales, such as the purchase of Eldeco early this year and most recently DECCO, Inc.
• Despite the strong performance, I have concerns about a potential reversal in growth and margins, leading to a cautious approach to investing in Comfort Systems USA, Inc.

In February, I concluded that Comfort Systems USA, Inc. (FIX) was demonstrating a comfortable level of performance to investors. This came as the business started the year with another bolt-on deal, as the business was performing well, despite operational headwinds.

The company has seen continued growth this year, with both sales growth and margin expansion looking strong, as lower dealmaking activity meant that the business has quickly deleveraged here, with the business even posting net cash holdings here.

This has sent Comfort Systems USA, Inc. shares another 40% higher from the levels seen in February, for good reasons, although I fear some kind of reversal, making me a patient buyer, although this time at a higher level.

About Comfort Systems

Comfort Systems USA provided mechanical electrics and plumbing installations across some 150 locations across the countries, although the business is overrepresented in Eastern parts of the U.S.

In the pandemic year 2020, Comfort generated $3 billion sales from these activities, largely derived from the industrial market, responsible for about half of sales. The remainder of sales were generated in education, office buildings, healthcare, and retail sectors, among others. In terms of the lifecycle of such real estate, the company is pretty balanced between new construction, maintenance, as well as special projects.

Because of the nature of the business, the company posts relative low margins. In the pre-pandemic year 2019, the company reported operating margins of 6.3% on $2.6 billion in sales, working down to earnings power around $3 per share.

Focus On Growth

The company engaged in some bolt-on acquisition activity since the outbreak of the pandemic, with the purchase of TAS Energy and Tennessee Electric, combined adding some $300 million in sales. The company acquired Amteck in 2021, adding another $200 million in sales, as a $50 stock pre-pandemic rose to the $100 mark early in 2022.

This came as investors were happy to see solid operating performance amidst a post-pandemic rally, with more bolt-on deals being announced over time as well. Shares fell to the $75 mark in the summer 2022, but recovered to a high around $135 in February 2023.

This came as the business reported its 2022 results, with fourth quarter sales up 30% to $1.12 billion, as operating margins of 7.2% were solid, working down to an earnings number of $1.54 per share. The run rate of earnings exceeded $6 per share, with actual earnings reported at $5.29 per share in 2022. With net debt down to $200 million, coming at roughly half the run rate in terms of EBITDA, leverage was low, although the business traded around 25 times earnings, still a lofty valuation.

The 36 million shares gave the company a $4.9 billion equity valuation at $135 per share, with the business valued at $5.1 billion. This increased a bit as the company announced the purchase of Eldeco, a South Caroline electrical design and construction service provider. The revenue contribution was pegged at $130-$140 million, although no purchase price has been announced.

The deal added 2-3% to pro forma sales, as I felt that the valuation was a bit too demanding to get involved, certainly after shares have nearly doubled from levels seen in the summer 2022.

Booming On

Since February, shares of Comfort Systems have gradually gained ground as they rose to a high at $200 and change in recent weeks, now trading at $190 per share.

In April, Comfort Systems hiked the quarterly dividend by two and a half pennies to $0.20 per share. First quarter results were reported a week later, with sales up 33% to $1.17 billion, and operating profits up two points to 6% of sales. This meant that operating profits doubled in dollar terms, with net earnings of $57 million working down to $1.59 per share.

The dividend was hiked to $0.225 per share in July, with second quarter sales up 27% to $1.30 billion, as operating margins expanded to 7.1% of sales, with diluted earnings reported at $1.93 per share.

In October, the company hiked the dividend again to $0.25 per share this quarter, as the practice of sequential hikes makes that the dividend is increasing rapidly. That being said, a $1 annualized dividend per share payout translates into a modest dividend yield of around half a percent here.

Third quarter sales rose by 23% to $1.38 billion, with growth slowing down on a sequential basis on the back of little acquisition activity taking place. Operating margins improved another 250 basis points to 9.8% of sales. This means that year to date sales are seen around $3.85 billion, with operating profits of $298 million coming in the high-7s.

This puts the company on track to generate about $5.2 billion in sales and to post operating profits of $400 million, with profits seen around $8-$9 per share here. The company has rapidly deleveraged the balance sheet , in fact, net cash is seen at $92 million, equal to $2.50 per share.

This all means that an unleveraged business is now trading at 21-23 times earnings. This is lower than was the case at the start of the year, but has been backed up by stronger than expected sales and margins, but raises the question if this might reverse as well.

And Now?

The reality is that the business has done very well, as and has rapidly deleveraged here, as M&A has been rather absent this year. The company did announce a bolt-on deal in recent times, as it purchased DECCO, Inc., a business set to add about $50-$65 million in sales, to thereby add a percent to pro forma sales.

I am deeply impressed by the continued strength of the Comfort Systems USA, Inc. business, in terms of growth and margins. This looks rather comforting, but raises concerns as well if growth, but notably margins revert to "normal" levels. Nonetheless, Comfort Systems deserves more credit than perhaps is given, making me tempted to keep a close eye on the shares here, looking to initiate a position on significant dips here.

This works down to a targeted entry level around the $150 mark, levels actually seen as recent as October, which might come within reach again. Hence, I am taking a cautious but patient wait-and-see approach, with the full intention of initiating a small position around the $150 mark, if Comfort Systems USA, Inc. shares should revert to those levels again.

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