Summary
- Comfort Systems USA, Inc. starts 2023 with another bolt-on deal.
- The company continues to perform well, despite emerging operational headwinds.
- I like the bolt-on dealmaking strategy of the business a lot, although Comfort Systems USA, Inc. investors are extrapolating current momentum perhaps a bit too far.
In April of last year, I believed that the situation for Comfort Systems USA, Inc. ( FIX ) was not too comforting. The company continued its bolt-on dealmaking strategy, to provide more critical tasks for clients to maintain building installations, a huge fragmented marketplace. Given its range of activities, the stock symbol appears to have been well-chosen.
Comfort Systems USA stock has seen solid revenue growth but incurred some margin pressure, something expected to last into 2022, as these margin headwinds made that I believed that the largest valuation re-rating (to the upside) had already taken place.
The Business
Comfort Systems USA provides mechanical electrics and plumbing installations across 150 locations, although the company has an overrepresentation in the Eastern parts of the U.S.
The company generated about $3 billion in revenues in 2020, largely from the industrial market, which is responsible for about half of revenues, complemented by exposure to education, office buildings, healthcare, retail, and other markets. The company has a pretty equal exposure across the life cycle of buildings, with a third coming from new construction, a third from maintenance and the remainder from special projects.
These are inherently low-margin operations, as Comfort posted operating margins of 6.3% in 2019 on a $2.6 billion revenue base, translating into earnings of around $3 per share. With shares trading at $45 pre-pandemic, valuations were reasonable. Following the outbreak of the pandemic, the company added $300 million in revenues with the acquisition of TAS Energy and Tennessee Electric, allowing sales and earnings to rise.
The Amteck purchase in 2021 added $200 million in sales, as dealmaking efforts and improved organic performance made that shares rally to the $100 mark at the start of 2022. This translated into a $3.7 billion equity valuation, including a modest $200 million net debt load. Valuations were running higher as earnings power came in around $4 per share, translating into an earnings multiple of around 25 times. This was in part the result of the Ivey Mechanical deal (announced late in 2021) and Edwards (start of 2022) which added another quarter of a billion in sales, as I pegged 2022 earnings power at $4.50-$5.00 per share.
By April, shares had fallen to $86 per share, mostly the result of some margin pressure seen, despite rapidly growing sales, causing earnings to continue to trend around $4 per share. In April, Comfort announced another bolt-on deal as the purchase of Atlantic Electric was set to add $50 million in sales, as leverage remained reasonable at 1.3 times EBITDA. That said, inflationary pressures and material availability issues were headwinds, which prevented me from buying the dip at $86.
Doing Fine
With exception to a brief move lower to $75 in the summer, Comfort Systems USA shares have gradually risen and in fact now trade at $135, just a few dollars from their highs. The reason for that is simple, as the operational news was quite good. In May of last year, the company increased its share buyback program to a million shares.
Dealmaking, organic growth, and inflationary impacts meant that second quarter sales rose 42% to $1.02 billion as operating margins ticked up ten basis points to 5.6% of sales, as net earnings were reported at $1.17 per share. Net debt was reported at $335 million, a very reasonable amount, with EBITDA trending around $300 million based on the annualized quarterly performance.
Third quarter sales rose an impressive 34% to $1.12 billion as operating margins of 7.3% look solid, even up 40 basis points on the year before, despite the aforementioned issues. A quarterly GAAP earnings number of $1.71 per share looks very strong, with realistic earnings now trending at $5 per share based on the results so far in the first three quarters of the year.
By February of this year, we saw that the company ended the fourth quarter of 2022 with a 30% increase in quarterly sales to $1.12 billion, although flat compared to the third quarter (that is on a sequential basis). Operating margins of 7.2% were up 140 basis points on the year before, translating into earnings of $1.54 per share, with realistic earnings power reported at $5.29 per share for the year.
This is far stronger than I believed possible at the start of the year, certainly after the release of the first quarter earnings report. Strong earnings and solid working capital management meant that net debt was down to $200 million, while EBITDA trends around $400 million based on the fourth quarter results.
The 36 million shares now give Comfort Systems USA a $4.9 billion equity valuation, or $5.1 billion enterprise valuation. This comes down to a valuation just in excess of reported revenues here, and about 25 times earnings pegged at $5.50 per share, huge multiples.
Another Deal
Alongside the release of the fourth quarter results , Comfort Systems USA announced the purchase of Eldeco, a South Carolina based electrical design and construction service provider. No purchase price was announced, yet given a $130-$140 million revenue contribution and a mere $8-$9 million EBITDA contribution, we know that the business is less profitable than USA Comfort. With the own business trading around 13 times EBITDA, I believe that the purchase price probably comes in around, or below $100 million.
This adds about 2-3% to pro forma sales, while keeping leverage below 1 times EBITDA, setting the company on track for continued growth in the coming year.
Note that shares of Comfort Systems rose 10% in reaction to the fourth quarter results, as the operating momentum continues despite a cooldown of the real estate markets, inflationary responses, and labor and material shortages, quite impressive.
Concluding Remark
Credits are due where they are due, and that is certainly with Comfort Systems USA, Inc. and its management, which embarked on a very good bolt-on acquisition track record alongside operating execution. This is to be applauded, yet the issue is that continued solid performance is only awarded by higher valuations over time, which prevent me from getting too upbeat about Comfort Systems USA, Inc. here.
Right now, I believe that the valuation is a bit too rich, but Comfort Systems USA, Inc. definitely deserves a prominent place on my long-term watch list.
For further details see:
Comfort Systems USA: Comfortable Performance