LMB - Greystone Capital - Limbach Holdings:  Despite Strong YTD Performance Significant Upside Remains

2023-07-31 13:40:00 ET

Summary

• Limbach Holdings is a construction and engineering services business that is successfully shifting its business mix to higher margin segments.
• LMB focuses on building systems solutions, such as plumbing and HVAC, and has a large recurring revenue profile.
• Despite the strong share performance year to date, I believe there remains significant upside as we are in the initial stages of the company’s execution.

The following segment was excerpted from this fund letter.

Limbach Holdings ( LMB )

My career experience in professional sports opened my eyes to how a strong culture can positively impact an organization. A strong culture is hard to find, quantify, and grow, but you know a good one when you see it, and you know a bad one when you see it. To get a sense of the strength of a business’s culture, I prefer to visit the company, meet with management and employees face to face, conduct channel checks with former employees and measure those things against competitors. It’s far from a perfect science, but businesses are a collection of people (which is the type of insight you’re here for), and how those people are treated, rewarded, and managed matters. A lot. Assessing the culture of a 100+ year old business isn’t something that can be done following a few weeks or months of due diligence (and in fact, I often get to know our businesses much better during our ownership), but one can put the pieces together by doing some of what I described above.

During the quarter we entered into a new position in Limbach Holdings, a microcap construction and engineering services business that is successfully shifting their business mix to stickier, more resilient, higher margin segments that over time will have the effect of contributing organic revenue growth, boosting margins and increasing cash flow generation. In the case of Limbach, and a number of our other businesses, I believe there are cultural reasons why the business has been around so long, and why they’ve succeeded in driving positive recent results.

Limbach considers themselves a building systems solutions business, that takes part in the design, installation, management, and maintenance of building systems such as plumbing, HVAC, mechanical and electrical components. The company has a decent presence throughout the US, with a focus on helping their end customers address mission critical systems. With a large recurring revenue profile, and with a presence in favorable and growing end markets, Limbach is well positioned to grow even in the face of economic pressures.

Limbach went public via SPAC during the initial part of the SPAC craze in 2016 and spent the next several years struggling to adjust as a public company while undergoing some operational missteps as they executed their strategy. I’ve followed the business since that time but remained on the sidelines due to concerns about the industry as well as the former CEO, a talented operator who for good reasons struggled to earn the market’s trust. He resigned earlier this year, clearing the way for current CEO Mike McCann, who I believe is the right leader to move this business forward.

Limbach has two business segments, General Contractor or ‘GCR’ and Owner Direct or ‘ODR’. The GCR segment, responsible for around 50% of revenues, manages new construction or renovation projects that involve some of the previously mentioned building systems. The GCR segment is a longer duration, lower margin business with significant competition, and is an area where historically Limbach has experienced some setbacks. GCR projects are typically commodity-based offerings with little ability to differentiate between vendors, and since projects are awarded by general contractors or construction managers, Limbach will typically have to accept the lowest bid given the level of competition. This is reflected in low gross margins for the segment as well as the lack of pricing power. Prior management put a large emphasis on GCR related projects, which aside from the negatives listed above, continuously ran into construction delays and cost overruns.

The ODR segment, responsible for the other 50% of revenues, earns revenues by providing owner direct construction projects and maintenance services. An example of this would be Limbach integrating themselves into the maintenance of a particular building’s systems, such as their HVAC or plumbing operations, developing a relationship with the building owner, and delivering reliable, high-quality work. I mentioned mission-critical above as the types of projects ODR seeks out involve maintaining systems that for various reasons can’t afford to fail. Think of the air conditioning system inside of a hospital. These services are assigned by building owners themselves, allowing Limbach to develop more of a recurring, relationship-based offering that is shorter in duration (thus better cash flowing) than GCR projects. Importantly, ODR work also sports higher margins and more opportunities for organic growth, with management targeting low teens revenue growth moving forward. As mentioned, as the portion of ODR revenues continues to grow, it will result in more recurring revenue, higher margins and increased cash flow generation, while leading Limbach to become an indispensable partner to their building owners.

A look at the income statement would reveal a shrinking set of GCR revenues, which is intentional as Limbach is now prioritizing the ODR segment as well as attempting to maximize margins within GCR. The revenue mix should reach 50/50 between GCR and ODR during 2023 with a 75/25 target between ODR and GCR over time. Management has mentioned being in the first inning of their growth strategy where they will be able to grow ODR revenues at a double-digit pace from here.

On top of the company’s strong organic growth prospects, there are significant opportunities for M&A, as Limbach operates in a very fragmented industry and value can be added by purchasing mom and pop operations that complement Limbach’s offerings. The company has successfully demonstrated the impact of accretive M&A using their net cash balance sheet, and this should only serve to bolster free cash flow per share moving forward.

As mentioned, Limbach is led by CEO Mike McCann, who has been an employee of 13 years and was handselected by the board to succeed the former CEO. Mike was chomping at the bit (his words) to take the helm at Limbach and in getting to know him over the past few months he reminds me of many of my former Spurs colleagues, as he is unassuming, laser focused on the task in front of him, and patient enough to be taking a very long-term view. I feel very good about Mike’s leadership as well as his adherence to the Limbach culture, which got its start over 100 years ago. Like a lot of our businesses, many employees have long tenures with the company, indicating that there may be something in the water at Limbach.

Despite the strength of the business, strong fundamentals, growth runway and balance sheet, we were able to purchase our shares around 5.0x EBITDA, a cheap price on both an absolute and relative basis. Past missteps with the prior management team along with the oft-hated engineering and construction industry in which Limbach operates means that shares are being valued like a cyclical, non-recurring construction company with most of their business tied to new construction projects. The reality is that this is a much stronger, more durable, and faster growing business today than it was just a few years ago, which means over time the market should come to recognize the strength of ODR as well as the potential to grow free cash flow per share, especially if Limbach gets the M&A engine revving.

There are many parallels between our investment in Sylogist and our investment in Limbach, namely a business with a checkered past, a favorable management change, a strategy shift, and the opportunity for organic growth, M&A, and strong capital allocation. Despite the strong share performance year to date, I believe there remains significant upside as we are in the initial stages of the company’s execution. I look forward to discussing Limbach in future letters.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

For further details see: