2023-08-09 12:35:24 ET
Summary
- Comfort Systems USA has experienced high growth driven by strong demand, but growth is expected to normalize.
- Q2 2023 earnings beat expectations with a 27.4% YoY increase in revenue and improved margins.
- The company's backlog and service business indicate continued revenue and margin growth, but the rate of growth is expected to slow.
Investment Thesis
Comfort Systems USA, Inc. ( FIX ) has seen an extraordinarily high growth rate over the last year and a half driven by strong end-market demand. While the company is still expected to continue its growth forward, the growth rate is expected to normalize. On the margin front, the company should benefit from increasing high-margin service projects, sales leverage, and moderating inflation. If we look at the current share price, these revenue and margin growth prospects seem to be already reflected in FIX’s higher-than-historical valuation. With the growth rate expected to normalize, I am not comfortable paying a premium for the stock. Hence, I continue to have a neutral rating on FIX stock.
Q2 2022 Earnings
Comfort Systems USA, Inc recently reported better-than-expected results for the second quarter of 2023. The company's revenue increased by 27.4% YoY to $1.3 billion , which beat the consensus estimate by $70 million. Adjusted EPS declined by 64.9% YoY to $1.93 and beat the consensus EPS estimate by $0.31. The gross margin increased by 40 bps YoY to 17.6% and the adjusted EBITDA margin increased by 100 bps YoY to 8.6%. The revenue increase was driven by healthy backlog execution, price increases, and acquisition synergies. Adjusted EPS and margins increased as a result of volume leverage.
Revenue Analysis and Outlook
In my previous article , I discussed Comfort Systems USA’s good growth prospects due to a healthy backlog and strong end-market demand driven by various infrastructure investment initiatives. The company has reported earnings for its second quarter of 2023 since then and similar dynamics were seen. In the second quarter of 2023, the company’s revenue growth benefited from a healthy end-market demand across the segments. In addition, strong backlog execution and price increases also benefited the top-line growth. This resulted in a 27.4% Y/Y increase in revenue to $1.3 billion. The revenue growth reflects a 24.2% Y/Y same-store growth (organic revenue) and a 3.1 percentage point growth from the Eldeco acquisition. The revenue growth was broad-based across the segments with a 25.6% Y/Y increase in the Mechanical segment and a 32.9% Y/Y growth in the Electrical segment.
Looking forward, I believe the company should be able to continue delivering revenue growth, benefiting from a healthy backlog, but the rate of growth should normalize.
The backlog, serving as an indicator of future revenue growth, has continued to show good levels of growth, which should continue to help the company’s revenue growth moving forward. Backlog in the second quarter of 2023, increased by 49.1% YoY to $4.19 billion. This strong growth reflects same-store backlog growth (organic growth) of 46.3% YoY and ~2.8 percentage point contribution from the Eldeco acquisition (acquired in February 2023). This reflects continued demand momentum across the segments, where the Mechanical segment backlog grew by 48.4% YoY and the Electrical segment backlog grew by 51.1% YoY. The Electrical segment backlog growth was also attributed to healthy pre-booking in the company’s modular business (off-site construction).
While the company delivered good year-over-year backlog growth driven by healthy demand, sequentially FIX saw a 5.8% QoQ decrease in total backlog due to strong backlog execution which led to the completion of many projects in the quarter. With the supply chain environment easing and project execution improving, I expect the backlog to continue to return to normalized levels. Revenue growth should also normalize as some of the benefits from past projects that were built up in the backlog due to supply chain constraints and pent-up demand go away. Further, revenue comparisons are also expected to get tough in the coming quarters on a 2-year stack basis.
Management is expecting revenue growth to normalize in the second half of 2023, due to tough comparisons in the coming quarters and has guided for full-year 2023 revenue growth in the high teens. This implies low to mid-teen growth in the back half, which no doubt is good but still less than 20% plus growth seen in the past several quarters.
Margin Analysis and Outlook
In the second quarter of 2023, the company continued to benefit from sales leverage and price increases, which helped it offset headwinds from inflationary costs. This resulted in a gross margin expansion of 40 bps YoY to 17.6%. On a segment basis, gross margin remained flat in the Mechanical segment at 17.8%, while margins in the Electronic segment increased by 190 bps YoY to 17%. Consolidated Adjusted EBITDA margin increased by 100 bps YoY to 8.6%. The growth in adjusted EBITDA margin also benefited from a 120 bps YoY decline in SG&A as a percentage of sales compared to the previous year's quarter.
Looking forward, I expect the company to keep delivering good margin expansion. The company should continue to benefit from volume leverage as revenue increases moving forward. In addition, the company’s price increases to pass through the impact of inflation on the customers should also help its margin growth. Moreover, speaking of inflation, the company’s major raw materials are also seeing moderation in prices which should also help in margin expansion moving forward.
Furthermore, as I discussed in my previous article, the company’s service business comprises high-margin projects. The company continues to post good growth in its service business. This has improved the overall project mix with high-margin business. The company is expecting to see growth in the service business continue as end markets remain favorable. So this improving project mix should also help margin expansion.
Valuation and Conclusion
Comfort Systems USA is currently trading at a P/E of 23.87x FY23 consensus estimate of $7.58 and a P/E of 20.82x FY24 consensus estimate of $8.69 which is above its historical 5-year average forward P/E of 18.52x. The company has good revenue and margin growth prospects but the rate of growth is expected to normalize looking forward. The stock is trading at a premium valuation as investors are rewarding it for good growth over the recent quarters. However, I would prefer to be on the sidelines as I believe the normalizing growth over the coming quarters might dampen some of the investor's enthusiasm. I like the company's growth prospects but the valuation is already pricing them at the current levels and I don't see much margin of safety.
For further details see:
Comfort Systems USA: Growth Prospects Are Already Priced In