2023-04-19 13:21:45 ET
Summary
- The increased demand in IESC's end markets, healthy order backlog, and acquisitions should benefit the revenue growth.
- The margins should benefit from improvement in project execution and declining raw material costs.
- I have a buy rating on the stock.
IES Holdings (IESC) is a leading provider of comprehensive electrical, communications, and other critical infrastructural services. With a wide range of expertise in designing and installing integrated electrical and technology systems as well as providing infrastructure products and services, IESC serves diverse end markets, including data centers, residential housing, and commercial and industrial facilities.
The company's operations are organized into four distinct segments, each specializing in a unique area of service. The Communications segment, which accounts for 26% of IESC's operations, focuses on providing network infrastructure solutions for data centers and other mission-critical environments. The Residential segment, which makes up the majority at 52%, is a provider of electrical installation services for single-family housing and multi-family apartment complexes, as well as HVAC and plumbing installation services and cable television installations for residential and light commercial applications. The Infrastructure Solutions segment, at 8%, specializes in providing enclosures for generators and enclosed bus duct solutions for power distribution equipment. Lastly, the Commercial & Industrial segment, representing 14% of the company's operations, provides electrical and mechanical design, service, and construction services to the commercial and industrial markets.
Over the past five years, IESC has experienced impressive revenue growth, with a CAGR of 22%. This growth can be attributed to various factors, including strategic acquisitions, pricing actions, and robust demand across its diverse end markets, which include data centers, housing, power, transportation, commercial, and industrial sectors. In the first quarter of FY23, IESC continued its upward trajectory, with a remarkable year-over-year revenue increase of 19.6% to reach $575 million. This growth was primarily driven by strong demand across its end markets and successful pricing actions.
Notably, the Communications segment of IESC experienced increased demand from data centers and high-tech manufacturing customers, contributing to the overall revenue growth. Additionally, the residential segment benefited from healthy demand and favorable pricing in the multi-family residential market, as well as the robust Florida single-family housing market. In the Infrastructure Solutions segment, the demand for IESC's generator enclosures remained strong in Q1 FY23, further contributing to the revenue growth. However, the commercial and industrial segment experienced moderate demand due to inventory destocking in its end markets.
Looking ahead, the increased demand for data centers and warehouses, moderate demand in the multifamily housing market, healthy backlog levels, and acquisitions should benefit the revenue growth. IESC had a healthy backlog of $1.33 billion at the end of December 2022, which is up 40% Y/Y. This will support the company's revenue growth in FY23.
Over the last few years, the building of data centers has increased due to cloud storage adoption, the Internet of Things (IoT), and the demand for streaming. Based on a report, the U.S. data center construction market is expected to grow at a 5.93% CAGR from 2022 to 2028 and reach a value of $28.56 billion in 2028. There are tax breaks offered by different states for the building of data centers. Maryland offers a tax-exempt incentive program that expands for 20 years for businesses that invest over $20 million in qualified data center personal property. North Carolina offers tax incentives based on the use of electricity used at qualifying data centers and data center support equipment. Additionally, the federal government's Inflation Reduction Act (IRA) provides tax incentives for the building of data centers.
The surge in online purchases has prompted e-commerce companies to invest in building new warehouses and retrofitting existing ones to meet the growing demand. However, with the weak macroeconomic conditions expected in 2023, I anticipate a slowdown in construction activity in the e-commerce sector. Despite this temporary setback, once the economy gains traction again, we can expect a ramp-up in warehouse construction to accommodate the projected growth in retail e-commerce revenue. According to the U.S. Department of Commerce, retail e-commerce revenue is anticipated to grow at an impressive compounded annual growth rate of 16%. This indicates a significant and sustained demand for online shopping, which will likely drive the need for more warehousing space in the future. As the e-commerce landscape evolves and consumers continue to shift toward online shopping, the demand for efficient warehousing solutions is expected to remain robust in the long term.
Despite the current challenges in the U.S. housing market, including rising mortgage rates and affordability concerns, there are positive indicators that provide a promising outlook for the residential market in the long run. One such indicator is the shift in demographic trends, particularly the increasing population of millennials who are entering the housing market. As this generation reaches the age of homebuying, their preferences and needs are expected to drive demand for residential housing, creating opportunities for growth in the residential market. Additionally, below-average housing starts in recent years may result in a potential supply-demand imbalance in the future. As new construction lags behind demand, it could lead to increased demand for existing homes, driving up prices and creating favorable conditions for sellers in the residential market.
On the profitability side, the operating margins have been improving over the last few years. However, in FY22, the margins declined due to poor execution on certain projects, higher input costs, and workforce disruptions related to COVID-19. In Q1 FY23, the operating margins improved significantly by 290 bps Y/Y to 7.1% due to the gain from the sale of the company's STR Mechanical business and strong demand for its services, particularly in the Residential segment.
Looking ahead, the company is efficiently executing its projects, which should benefit margins in FY23. Additionally, certain raw material costs are below their 2022 highs, which should help improve the company's profitability. Hence, I am optimistic about the company's margin improvement prospects.
Valuation
In my DCF calculations, I am assuming revenue growth to be in the mid-teens in FY23 given the healthy order backlog, strong demand, and acquisitions. Beyond FY23, I have assumed growth to be in the high single digits, with a terminal growth rate in the mid-single digits, as the company will continue to benefit from the trends across its different end markets. I am anticipating the debt-ratio to remain constant and net CapEx to increase year after year as the company invests in expanding its business. I used a discount rate of 7.33% and arrived at a fair value of $69.32 for IESC.
Risks
- IESC generates majority of its revenue from the residential market and if the decline from this market outgrows the benefits from other markets, the company's revenue should be impacted.
- Raw material costs are difficult to predict and they impact margins negatively, if its prices rise.
Conclusion
In summary, I have a buy rating on the stock given the healthy revenue and margin growth prospects. The company should benefit from the healthy demand in its end markets, including, data centers, multi-family housing, power generation, and warehousing. Additionally, the strong order backlog levels and acquisitions should support revenue growth. On the margin front, IESC is improving its project execution which should improve profitability in the near and medium term.
For further details see:
IES Holdings: Electrifying Growth Prospects