EVI - EVI Industries: A Strong Company In A Challenging Setup

2023-12-19 06:59:08 ET

Summary

• EVI Industries aims to grow through a "buy-and-build strategy" involving technological transformation and acquisitions.
• The company has consistently increased its installed customer base and expanded distribution territories and collaborative strategies.
• EVI faces challenges with low-margin contracts with the federal government and increased operational complexity, but its low leverage provides assurance during economic downturns.
• It has a robust balance sheet.

EVI To Hold It Steady

EVI Industries ( EVI ) sells, leases, and distributes commercial laundry equipment. The company aims to grow through a "buy-and-build strategy," which involves technological transformation requiring enterprise resource planning and acquisitions. It has consistently increased its installed customer base while expanding distribution territories and collaborative strategies with its partners. Its strategies have led to higher operating profit over the past several years.

Despite the long-term drivers steadying the company in a competitive market, EVI faces some challenges. Some long-term contracts are with the federal government, which offers low margins. Also, an increase in its installed equipment base has increased operational complexity, leading to revenue and margin pressure. As the economy delves into low-activity levels, the outlook is uncertain in the near term. The company's low leverage can assure investors when the economy underperforms. The stock appears marginally overvalued. I think investors should "hold" it for an improved return in the medium-to-long term.

The Recent Value Additions

Over the past few years, EVI has focused on a technological transformation, focusing on enterprise resource planning systems. Because it primarily distributes commercial laundry products, the ERP system is the foundation of a broader technology strategy. As the ERP system implementation nears completion, it aims to gain market share as it acquires new customers. The company has also regionalized operations and implemented new technologies at legacy business units. This way, it has optimized the newly acquired businesses and lower costs, leading to margin expansion.

As a part of its "buy-and-build strategy," it acquired ALCO Washer Center in Q1. ALCO is a commercial laundry distributor and service provider in the northeast region. The acquisition supplemented its regional customer base and added a pool of service technicians. To understand the impact of its strategies, let's look at the topline and margin growth over the years. Since 2016, its revenues and adjusted EBITDA have grown by 37% and 35%, respectively. The company estimates that its installed base of commercial laundry equipment has also increased. The company has invested in expanding its distribution territories and collaborative strategies with its OEM partners.

The Long-Term Value Drivers

EVI sells and distributes laundry equipment to vended laundry facilities, industrial laundry facilities, various government institutions, educational institutions, hotels, and corporations. Its products include finishing equipment, material handling equipment, mechanical equipment, boiler products, and replacement parts. The company has acquired eight companies since 2015. For distribution, it purchases industrial laundry products from outside vendors. Sales from outside for distribution accounted for 61% of its total sales in FY2023.

EVI operates in an intensely competitive industrial laundry and boiler distribution market in the US. The market is highly fragmented, with independently owned distributors and foreign manufacturers. In this environment, the company aims to build and maintain its market share through high-quality products, in-house installation, maintenance and repair services, and prompt delivery of equipment. So, it has built a network of technicians, optimized equipment inventories, and invested in advanced technologies.

The Economy And Industry

The ISM Manufacturing PMI was 46.7 in November due to an order softness in the manufacturing sector. The US unemployment rate was high (3.9%) in October. So, the PMI's remaining below 50 and a relatively high unemployment rate point to uncertainty in the industrial environment and economy.

Quarter-over-quarter, the average US GDP growth rate was 1.5% in the past four quarters. The US consumer price index (or, CPI) increased by 0.8% during this period. So, the economy indicates an uncertain sign for EVI's near-term outlook.

Analyzing Q1 Performance

Year-over-year, EVI's revenues increased by 5.6% in Q1 2024. Robust backlog translated into higher sales in Q1. Its gross margin remained nearly unchanged over the past year. Strong customer value proposition improved its profitability in Q1. A rise in selling expenses related to technology investments and higher expenses following the new business acquisitions cropped the margin growth.

The rise in selling expenses reflected increased commissionable sales and increased headcount of sales professionals. The company will likely keep investing in modernizing and optimizing its operations, which can keep its operating margin under check.

Cash Flows And Balance Sheet

In Q1 2024, EVI's cash flow from operations turned mildly positive compared to a negative CFO a year ago, primarily due to the company's rise in revenues and improved working capital. However, its free cash flows were null in Q1 2024.

EVI's liquidity was $59 million as of September 30, 2023. Its leverage (debt-to-equity) of 0.25x is lower than its peers' average (KRT, HDSN, and WHR). During Q1, the company required less net borrowings to support working capital changes.

The Potential Margin Challenges

EVI typically enters into large laundry project contracts for the long term with the federal government. However, such federal contracts can attract lower gross margins than other equipment sales. Nonetheless, the long-term benefit from the increase in its installed equipment will outweigh the short-term adverse impact on gross margin.

The other challenge lies with the installation base. Because the company operates in the commercial laundry industry, such installations can vary from single equipment units to complex laundry systems. This requires coordination and collaboration with its customers. Delays in the construction of customer facilities for the purchased commercial laundry equipment and system can affect revenue recognition and lower revenue and profit margins.

Relative Valuation

EVI's forward EV/EBITDA multiple is expected to remain versus its current EV/EBITDA. In comparison, the multiple is expected to decrease mildly for its peers. This means EVI's EBITDA will likely remain unchanged versus a rise in EBITDA for its peers. This typically results in a lower EV/EBITDA multiple. The company's EV/EBITDA multiple (17.6x) is much higher than its peers' (KRT, HDSN, and WHR) average (9.6x). So, the stock appears to be moderately overvalued at this level.

If the stock trades at the past average, it can more than double from the current level. Given the near-term drivers, I do not think it will trade anywhere near the past average. However, it can give steady returns in the medium term.

What's The Take On EVI?

The ERP implementation and operational regionalization have allowed EVI to gain new customers. It focuses on providing high-quality products, in-house installation, maintenance, and repair services to achieve growth. The other growth factor is the new business acquisition strategy. It has acquired eight companies since 2016, which led to revenue and margin growth during this period.

However, the economic and industrial outlooks do not hold many promises in the near future. The fragmented nature of the laundry products and services industry will continue to limit margin expansion. So, the stock underperformed the SPDR S&P 500 Trust ETF ( SPY ) in the past year. It has a robust balance sheet, which should insulate against any adverse economic changes. It currently trades at a premium compared to its peers. So, various drivers appear to run against each other in the current scenario. Considering all of these, investors would do well to "hold" the stock.

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