2023-10-06 14:55:35 ET
Summary
- IES Holdings reports strong demand in Florida single-family markets.
- The company appears to be reporting impressive EPS growth in 2023, double-digit net sales growth, and triple-digit operating income growth.
- My new numbers are a bit better than in the previous report. I assumed a lower WACC, and higher terminal multiple because the company reported EPS growth, and restructuring.
IES Holdings, Inc. ( IESC ) recently reported an impressive increase in quarterly EPS growth driven by strong demand in Florida single-family markets. With these beneficial figures, I also expect further earnings growth thanks to recent reorganization efforts announced in the residential segment and backlog growth in 2023. There are obviously significant risks from failed M&A efforts or failed geographic expansion, however I believe that there is still an upside potential in the stock price.
business Model
With a wide variety of end markets to introduce its products to, IES Holdings designs and installs integrated electronic and digital systems. It also provides infrastructure products and a series of related services to its clients.
It is not the first time that I am covering IES Holdings. In my previous article , I noted that the company was interesting because of the developments of the residential segment. Recent information delivered about this specific segment and operating improvements indicate that I was not wrong. With this in mind, I want to run more financial models.
With that about the previous stock performance, let’s reassess the business model. Among its clients, data storage centers stand out over businesses and residential homes. In the same sense, it is important to highlight that the company does not have great concentration in relation to its clients since none of them accounted for more than 10% of the company's annual revenue for the last three fiscal years.
The operations are divided into four segments that respond in turn to the type of service that the company offers. They include the communications segment, the infrastructure solutions segment, residential products, and the segment for industrial clients and the aerospace industry. At the statistical level, the segment that currently represents the most revenue for the company is the residential products segment, well above the other segments.
For the segment that represents the largest amount of revenue for the company, the services include the installation of electrical systems and ventilation systems such as air conditioners and heaters that target multi-family complexes and single-family homes. The concentration of this service is provided mainly in Texas and Florida, and the objective appears to be to continue establishing strategies to increase profits on the provision of services to multifamily complexes through contracts with the respective concessionaires.
The communications segment, for its part, offers technologies for the infrastructure of communication networks nationwide, while the other segments offer electromechanical systems for industrial and aerospace infrastructure as well as equipment repair and maintenance services.
Recent Changes Since The Last Time I Covered IES: Backlog Growth, And EPS Growth
I believe that it is a great time for having a look at IES considering the recent increase in the quarterly backlog. In the last quarterly report, IES reported that the backlog increased from close to $1.2 billion in 2022 to about $1.5 billion in June 2023. If the company successfully fulfills its obligations with clients, I think that we may see net sales growth and FCF growth in the coming years.
Another beneficial feature has been noted in 2023. The company appears to be reporting impressive EPS growth in 2023, double digit net sales growth, and triple digit operating income growth. In my view, if investors continue to see improvements in terms of profitability, the stock price would most likely increase. I did not see such EPS growth when I wrote my previous article.
Balance Sheet
As of June 30, 2023, the company reported $28 million in cash, $340 million in trade receivables, inventories worth $102 million, and total current assets close to $604 million. The current ratio is equal to 1x, and the company does not report debt, so I believe that liquidity or solvency is really not an issue here.
Property and equipment stands at close to $56 million, with goodwill of $92 million and intangible assets close to $60 million. Total assets are equal to $899 million, and the asset/liability ratio stands at about 2x. In sum, I believe that the balance sheet appears stable.
With regards to the total amount of liabilities, it is worth noting that IES paid its long-term debt recently. Besides, in 2023, the total amount of liabilities decreased substantially. Right now, total liabilities are equal to $440 million with total current liabilities close to $370 million.
New FCF Catalyst: Strong Demand In Florida Single-family Markets, And Further Investments In The Residential Services Segment Could Bring FCF Margin Growth
The company's current strategy aims to generate long-term value for its shareholders, and this objective is intended to be achieved through geographical expansion in the United States as well as expansion in the markets in which it is already present, emphasizing the residential services segment. It is worth noting that management is experiencing significant margin growth thanks to price increases in connection with higher materials and strong demand in Florida single-family markets. Considering this type of growing market, I believe that further investments will most likely lead to FCF growth.
" Our Residential segment's revenues increased by $138.3 million, or 17.2%, during the nine months ended June 30, 2023, compared to the nine months ended June 30, 2022. The increase was driven by the impact of price increases in connection with higher materials costs and continued strong demand, particularly in the multi-family and Florida single-family markets. " Source: 10-Q
Acquisitions And Divestitures Could Accelerate Transformation, And Serve As Catalyst For FCF Growth
The acquisition strategy plays a fundamental role in the company's growth strategy since it targets businesses that offer similar services and allow it to expand its national geographical presence. The company also looks for businesses that offer services related to expanding and diversifying the offer for its clients. It is worth noting that IES appears to have a lot of expertise in the M&A markets, which would most likely facilitate new deals. As shown in the chart below, goodwill increased in the last ten years from less than $40 million to more than $160 million.
With the recent acquisitions being mentioned, IES has not really bought anything remarkable in 2023. Taking this into account and the current state of the balance sheet, which does not include debt, I believe that seeing a new acquisition announcement every day is a bit more likely. As a result, if the market does appreciate the new transaction, we may see stock price increases.
" We completed no acquisitions during the nine months ended June 30, 2023 or during the year ended September 30, 2022. " Source: 10-Q
I also think that divestitures could serve as relevant catalysts for the stock. It is worth noting that the company sold interests in STR Mechanical, LLC. New divestitures may be celebrated by the market if they bring new cash to the balance sheet.
" On October 7, 2022, we sold 100% of the membership interests of STR Mechanical, LLC and its subsidiary Technical Services II, LLC (collectively, “STR”). As a result, we recognized a pre-tax gain, which was included in “Gain on sale of assets” within our Condensed Consolidated Statements of Comprehensive Income for the nine months ended June 30, 2023." Source: 10-Q
The Company Announced The Reorganization Of The Residential Segment's Management Structure, Which May Also Bring Operating Margin Improvements
Due to the increase in general costs for the workforce and the purchase of inputs as well as the inflationary situation of the economy, the company aims to draft its cost structure to maintain competitiveness in the face of a considerable decrease in demand throughout its segments, specifically in residential services. In this regard, the reorganization announced in the last quarterly report is worth noting, which may have beneficial effects in the cash flow statement in the coming years.
" Selling, general and administrative expenses for the three months ended June 30, 2023 also included $3.6 million of severance charges, as we reorganized the segment's management structure. In connection with this reorganization, we also began combining multiple administrative facilities into a single location and consolidating several underperforming branches, resulting in higher administrative expenses in the three months ended June 30, 2023 as these steps were implemented. " Source: 10-Q
My New Free Cash Flow Model
With my previous assumptions, and recent earnings growth I changed a bit my expectations. In my previous article I obtained a minimum valuation of $28 per share, and a maximum valuation of $111 per share. My new numbers are a bit better than in the previous report. I assumed a lower WACC, and higher terminal multiple because the company reported impressive EPS growth, and restructuring efforts. In my view, demand for the stock, and lower stock volatility will most likely lower then cost of capital.
My DCF model includes numbers that are close to figures seen in the past in previous cash flow statements. Changes in receivables, changes in inventories, changes in working capital, and net income growth are close to that reported by IES in the past.
More in particular, I included net income growth so that 2029 net income would stand at close to $393 million. Besides, with depreciation and amortization of about $7 million and non-cash compensation of -$22 million, I also assumed amortization and impairment of operating lease rights of use assets of about $72 million.
With no loss on equity method investments or write-off of other comprehensive income, I did assume deferred income taxes of about $149 million, changes in patient accounts receivable of -$59 million, and changes in accounts payable of about $23 million.
Finally, considering accrued expenses close to -$288 million, other long-term obligations worth -$97 million, and changes in operating lease liabilities worth -$66 million, I obtained net cash provided by operating activities of $159 million. If we also assume purchases of property and equipment of about -$9 million, 2029 FCF would be close to $150 million.
My DCF model took into account that IES traded, in the past, at close to 11x-16x FCF, and I also assumed that the cost of capital would range from 6% to about 10%. Under these conditions, I obtained a maximum valuation of $114-$115 per share, a minimum valuation of $74-$73 per share, and a median valuation close to $90 per share. I believe that the fair value is probably close to the median stock valuation, however the stock appears to be trading undervalued in most cases. The internal rate of return could be as large as 11%.
Competitors
The services offered by the competition vary in each of the segments, although the general trend in these markets is the participation of a large number of small businesses as well as independent contractors. This stands out in the residential segment since the regional offer is concentrated in a large number of installers and technicians who generally do not have access to large capital, therefore they do not represent a greater competitive risk for IES holdings.
Risks
Regarding the risks that coexist with this company, we must first highlight the current situation of the economy, which directly affects the demand for its services. This factor, added to the levels of competitiveness that exist in each of the markets in which it participates and the recognition of income through fixed rates for contracts, generates uncertainty in the short term. The adaptation of the pricing strategy that allows sustaining operating costs and maintaining competitive margins in this sense plays a fundamental role for the company at this moment.
In addition, the company's ability to generate new contracts as well as the risks that arise from an active acquisition strategy are part of this analysis. We must also mention that there is a majority concentration of the shares of this company in the hands of a single shareholder, which, of course, implies a potential dispute of interests over the sale and purchase of these shares.
" A majority of our outstanding common stock is owned by Tontine Associates, L.L.C. ("Tontine Associates") and its affiliates (collectively, “Tontine”). Tontine owns approximately 57 percent of our outstanding common stock. As a result, Tontine can control most of our affairs, including most actions requiring the approval of shareholders, such as the approval of any potential merger or sale of all or substantially all of the Company's assets or business segments, or the Company itself. Most of Tontine’s shares are registered for resale on a shelf registration statement filed by the Company with the SEC. " Source: 10-k
Conclusion
IES recently reported an impressive increase in backlog and an impressive increase in EPS growth. Considering previous expertise in the M&A markets, incoming expansion in the residential segment, and strong demand in Florida single-family markets, I believe that expecting further FCF margin growth makes sense. There is also the recent combination of multiple administrative facilities into a single location in the residential segment, which may bring beneficial operating margin improvements. In my view, even considering risks from failed M&A or failed geographic expansion, I believe that IES could trade a bit more expensively.
For further details see:
IES: Significant EPS Growth, Backlog Growth, And Reorganization.