LMB - Limbach Offers It All: Meaningful FCF Organic Growth M&A And Potential For Multiple Expansion

2023-05-31 00:21:50 ET

Summary

• Despite being up 4x in the last 12 months, LMB has a credible path to appreciating by an additional 3-5x over the next few years.
• The company is undergoing a significant business transformation, shifting from general contractor projects to building-owner customers, resulting in higher margins and lower volatility.
• LMB shares remain very cheap today, selling for 6x EBITDA and 9x FCF, a significant discount to peers that trade for double-digit EBITDA and high-teens FCF multiples.
• The company is in a net cash position and is deploying its FCF into highly accretive tuck-in acquisitions at 4-5x EBITDA. Between organic growth and M&A, I believe EBITDA can be up 2-3x over the next few years.
• LMB is imminently being added to the Russell 2000. Several sell-side firms have estimated net demand of 1.4m shares from the index inclusion, which could create a near-term catalyst for the stock.

Business overview

Limbach ( LMB ) is a HVAC focused specialty contractor undergoing a major business transformation that investors have yet to fully appreciate. You can see what I wrote about the company in 2020 here . The company’s most recent investor presentations can be found here .

Historically, most of the company’s business came from large projects bid out by general contractors – this work requires major investment into working capital, and comes with low margins, and high margin volatility.

Today, ~60% of gross profits come directly from building owners (up from 30% just a few years ago) – this work comes with lower capital intensity, higher margins, and lower margin volatility.

Additionally, LMB is quickly becoming a value-added service partner to its building-owner customers who rely on the company to keep their mission-critical infrastructure online.

Not only has this mix towards owner direct work driven consolidated gross margins and EBITDA margins higher, but it has allowed the company to be much more selective on the contractor work that it takes on as well, leading to margin expansion and lower volatility in this segment as well.

Over time, the business should continue to grow its owner-direct business at a much faster pace than GC business, which should continue to drive consolidated margins higher.

New management

After first investing in LMB in 2020, I exited my position in 2021 due to mounting frustrations with the company’s former CEO, some of which I highlighted here . I was not alone – many other institutional investors that I spoke with refused to take a closer look at the company because of the reputation of the person running the show. Earlier this year, the company appointed a new CEO who I believe to be very impressive for a company of this size. New investors are starting to take notice and I believe this change in management significantly increases the odds that LMB stock will benefit from broader institutional ownership and a much higher multiple in due time.

Clean balance sheet and M&A

The company currently sits in a net cash position and plans to use its free cash flow to make bolt-on acquisitions at 4-5x EBITDA. These acquisitions will not only add geographic and project diversification to the business but will also be meaningfully accretive to FCF per share.

Room for multiple expansion

While LMB currently sells for 6x EBITDA and 9x FCF, its closest comps sell at significantly higher multiples. I believe that over time LMB will close this multiple gap.

Upside to consensus

For 2023, LMB guided to EBITDA of $33-37 million. Consensus is modeling $34 million for the year. However, the company generated $9m of EBITDA in Q1, which is typically a seasonally slow quarter.

When I asked management if there were any one-time benefits in the quarter that were unlikely to be repeated, they said no. When I asked if they still expect typical seasonality throughout the year they said yes.

As such, I believe a conservative estimate of 2023 EBITDA is $36 million, with potential for the company to generate $40m+ this year. While Q1 is too early in the year to increase guidance, there is a chance the company increases its 2023 guidance on its Q2 earnings call.

Russell 2000 inclusion

Every year, the Russell indexes undergo a reconstitution to ensure they maintain accurate representation of listed companies. This year the newly reconstituted index is set to take effect after the market closes on June 23.

In its preliminary additions list , Limbach appears to have made the cut, and its addition into the index is highly unlikely to change at this point. Several sell-side firms have put out estimates that show there should be net buying demand for 1.4m shares of LMB due to the company’s addition into the index.

The 1.4m to buy represents more than 10% of the company’s outstanding shares, and nearly 6 weeks of average trading volume. I believe that holders of the shares believe they are worth much more than current prices and that index buyers will have to bid the stock up significantly to get the shares they will be required to buy for the index rebalance.

Illustrative financial model

Below are illustrative projections showing what the financial profile of the company could look like if it continues to execute on the transition towards owner-direct services and reinvests its FCF into accretive M&A.

For further details see: