LMB - Limbach Holdings: Exciting Times Ahead

• Limbach Holdings' transformation is ahead of schedule.
• Management is executing its goals of increasing ODR revenue and improving GCR margins.
• Tailwinds abound over the next 3-5 years.
• Modest growth and margin assumptions support a share price above $30.

Limbach Holdings' ( LMB ) operational transformation is ahead of schedule. The company has made substantial progress growing ODR segment revenue and improving margins since my last write-up in September of 2021. LMB is benefiting from multiple tailwinds and recent legislation (CHIPS Act and Inflation Reduction Act) should foster a favorable operating environment for many years to come. If the operating environment remains favorable and we accept the most conservative long-term estimates provided by management, LMB has the potential to be a multibagger over the next five years.

A Quick Refresher on the Investment Thesis

LMB is a specialty contractor that focuses on HVAC, plumbing, and electrical systems. The company has two segments, one that focuses on new construction and installation projects and another that provides maintenance and servicing work to existing systems. New construction work is awarded via general contractors; this segment is named "General Contractor Relationships" (GCR). Maintenance and service work is generally awarded directly by building and facility owners; this segment is named "Owner Direct Relationships" (ODR). Historically GCR made up the majority of LMB's revenue, but GCR's margins are much lower than the ODR segment (roughly 13% for GCR vs 25% for ODR). Management has been working to grow the size of the ODR segment and pare back the GCR segment, with the goal of bringing the two divisions into revenue parity by 2025. The investment thesis is to buy the company today while the transformation is still in progress and the stock is cheap relative to its future performance potential.

LMB Reported Strong Q2 Results and Guidance

LMB reported strong Q2 earnings and gave encouraging guidance for the rest of FY 2022. Overall revenue fell YoY as the GCR segment shrank 24%, but operating income improved as ODR segment revenue grew a whopping 48%. GCR margins improved from 10% to 13%, in line with management's plan to sacrifice total revenue in favor of more profitable work. ODR margins settled at 25%, which is the bottom of management's long-term expectations range of 25-28%, but still nearly double GCR's improved margin. ODR revenue made up 40% of LMB's total revenue in Q2, up from 26% the previous year.

FY 2022 guidance looks solid. Management expects revenue to be in the range of $510 million to $540 million with adjusted EBITDA of $25 million to $29 million. More of the adjusted EBITDA looks to be translating to free cash flow than in the previous year; cashflow from operations is sitting at $12.6mm through Q2. Other relevant guidance included a slowing but meaningful ODR segment revenue growth rate in "the low teens" and a long-term SG&A target of 13-13.5% of revenue

Model Assumptions and Thoughts on Valuation

Putting together Q2 performance and management's guidance, the future looks bright for LMB. I did a simple modeling exercise for the next five years, starting with FY 2022 projected revenue and margins across the two segments and then layering in management's revenue growth and SG&A targets. The following scenario assumes that ODR segment revenue grows 12% per year, GCR revenue declines at the same pace, and SG&A settles in at 13.5% of revenue. These are all the low-end of management's target ranges. FY 2022 income and EBITDA come out higher than the provided guidance, but this is primarily because Q1 performance was below these projections. All dollar values are in millions.

These numbers are impressive when compared to LMB's $75mm market cap and $110mm enterprise value. A modest PE multiple of 10 or an EV/EBITDA multiple of 8 would both support a market cap above $350mm, which translates to a share price north of $30.

The immediate critique of this scenario is that it relies on management estimates and projections, which haven't been 100% reliable. Projecting future performance is difficult, even if management has good intentions and isn't being unrealistically optimistic. That being said, consider that applying even a 50% margin of error towards the $30/share projection still gives a share price that is double the current $7.15 share price. That is a healthy margin of safety applied to conservative estimates that still results in outsized returns.

I think there is a real chance LMB achieves their goals. There are numerous industry tailwinds that support management's growth projections over the next 3-5 years. LMB has heavy exposure to growing industries and sectors, including solar energy production, data centers, semiconductor manufacturing, and healthcare. Federal and state government spending programs tied to last year's bipartisan infrastructure legislation are just beginning to kick off, and the recent passage of the CHIPs bill and Inflation Reduction Act will provide further support in the coming years. LMB's recent acquisition of Jake Marshall gives the company more ways to benefit from this type of spending. CEO Charlie Bacon discussed an example on the last conference call:

The frequent announcements of plant relocations and new plant expansions is encouraging. Within the last several weeks, one of Jake Marshall's most prominent customers announced a multi-year $200 million plant expansion to produce specialty silicon products at the facility in Chattanooga." ( Source )

These tailwinds suggest that management's targets are reasonable and that the company could even surpass expectations.

Risks

In addition to the usual risks associated with micro-cap companies (low share liquidity and high daily volatility), the two biggest risks to the investment thesis are the reliability of management's estimates and potential shifts in the macroeconomic climate. The ODR segment is growing nicely now, but recent strong performance has been against the backdrop of increasing demand for services and pricing power for suppliers of these services. I think increased government spending should provide protection against a retail market recession, but if ODR growth falters or margins compress, then the outcome for LMB will be worse than projected. LMB could underperform management's estimates and still be a good stock to own, but lack of faith in management would likely hurt investor confidence and lower earnings multiples.

Conclusion

LMB doesn't have to hit consecutive home runs to reach a $30 share price; 12% revenue growth in the ODR segment, declining GCR revenue, no margin expansion, and modest multiples are enough to make the company a multibagger over the next five years. Is it possible that LMB underperforms these projections? Absolutely. However, if I can be off by 50% and still double my money, that is an appealing bet to make. I continue to hold my long position in LMB and will consider adding to my position on future dips.

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