Comfort Systems USA (FIX)
Comfort Systems USA FIX 0.00%↑ is a $10B market cap HVAC and mechanical systems installation and service provider mainly for industrial end markets.
Quality (3/5)
Comfort Systems USA’s revenue growth accelerated greatly after the pandemic. The 10-year CAGR for revenue is 14%, while the 3-year CAGR is 22%. That growth rate is a bit high for my liking compared to the usual MSD-LDD range that I prefer.
Looking at the historical chart above, there are many bursts of revenue growth (somewhat aided by acquisitions), all followed by slower growth or revenue declines. However, the company is on 25 straight years of positive free cash flow despite the ups and downs in sales. In addition, there have been 11 straight years of dividend increases, although the current dividend yield is only 0.3%.
As the company name implies, revenue is based 100% in the United States. Texas accounts for 24% of total revenue.
Leverage, as measured as total assets / total equity, is not excessive at 2.6X today.
Visibility (4/5)
Comfort Systems USA recently reported backlog increasing to over $5.1B, up from about $1B pre-pandemic!
“At any given time, between 80% and 90% of our backlog is work that's already in progress. So it's the cost -- we don't put something in the backlog until after we have a price and a scope and a commitment. And that almost always happens after the building has already started because somebody -- so we have had very, very few cancellations over the last 25 years. Until COVID, we had only had 1 cancellation over $20 million, something that went into our backlog and came out.
During COVID, we had $60 million or $70 million that we took out of backlog because they were put -- in the middle of work, some stuff was put on hold with no recommencement date. All of that work has come back and been finished. So our definition of backlog is so strict that we rarely, rarely -- people just don't build -- have build a building in stock, very much in the U.S. Most places, it's illegal to do that. So our backlog is very firmly committed historically. It's possible they say stop stuff for a period of time. If anybody says stops stuff, if they don't have a recommenced date, we take it out of backlog because we have a super strict definition of backlog we just always have.
But the quality of our backlog has never been better. It's a astoundingly good. It's really good. It's worked -- yes, it's astoundingly good. It's never been better.” (FIX: 2023 Earnings call 3 2023 Transcript, 2023-10-27)
This “astoundingly good” backlog should provide decent visibility in the near-term. However, longer-term, visibility is lower due to unpredictable macroeconomic factors that impact customer’s construction needs.
During downturns, the increasing Services base provides a steady revenue stream. Services is now 20% of total revenue.
While the projects that Comfort Systems USA engages in are very complex, I would say the company falls into the “boring” category. There are exciting demand drivers like data center and AI, but the HVAC systems that cool the AI servers are probably not going to be getting as much screentime as Nvidia’s fancy new chip. In fact, there are usually only four analysts on FIX’s earnings calls.
Management (5/5)
Brian Lane (66) has been CEO since 2011 and joined FIX in 2003. The CFO, since 2005, is Bill George (59), who joined the company in 1997. My initial impressions are very positive of this experienced management team.
Cumulatively, over the last decade, management generated $1.2B of free cash flow, while spending $0.9B on acquisitions. Management provides a chart of its average capital allocation between 2007-2023 in its investor presentation, where one can see how acquisitions are the priority for the company.
Here are the latest acquisitions:
Feb 2, 2024: J & S was founded in 1976 and provides mechanical construction services to commercial and industrial sectors across the Mountain West region of the United States. J & S works on many of the largest and most technical construction projects in their region.
Initially, J & S is expected to contribute annualized revenues of approximately $145 million to $160 million, and earnings before interest, taxes, depreciation, and amortization of $12 million to $15 million. In light of the amortization expense, J & S is expected to make a neutral to slightly accretive contribution to earnings per share in 2024 and 2025.
Feb 1, 2024: Summit is a specialty industrial mechanical contractor offering engineering, design-assist and turnkey, direct hire construction services of modular systems serving the advanced technology, power, and industrial sectors. Summit’s capabilities encompass a wide range of modular and site-based construction, including process piping, equipment setting, large pipe rack trestles, and related steel erection and specialty concrete work. Summit is a trusted supplier to some of the world’s largest advanced technology, power and industrial companies and is currently deployed on several major chip fabrication projects.
Initially, Summit is expected to contribute annualized revenues of approximately $360 million to $400 million, and earnings before interest, taxes, depreciation, and amortization of $30 million to $45 million. In light of the amortization expense, Summit is expected to make a neutral to slightly accretive contribution to earnings per share in 2024 and 2025.
Management noted that the Summit acquisition was the company’s largest ever. Check out Summit’s website for examples of its projects.
Continuing, management limits its use of dilutive share-based compensation. Shares outstanding are down to 35.5M today compared to about 40M ten years ago.
Management is incentivized by EPS and FCF performance, according to the latest proxy filing. Insiders own 2.2% of shares outstanding.
Demand Creation (4/5)
My initial impression is that Comfort Systems USA has some demand creation ability. Through its hiring and training programs, it is able to have more skilled workers and take on more and larger projects. When times are good, like today, there is still more demand than the company can handle. It has the luxury to pick and choose which projects to take on. During slower times, FIX is at the mercy of lower demand for construction by customers. As mentioned in the backlog quote above, some projects can get cancelled.
Comfort Systems USA has a size and scale advantage with 15,000+ employees and over 170 locations nationwide. It would be difficult for new entrants to hire, train, and certify a workforce to match. This size also provides a cost advantage for FIX when ordering parts from suppliers.
FIX has a reputation for high-quality service. with many of its companies operating for over 70 years. Its services are mission critical to completion of a successful project on time. If Comfort Systems USA disappeared tomorrow, many projects would run into huge delays and cost overruns, plus customers would lose a long-time, trusted partner.
Valuation & Pricing (2/5)
Attached below is my discounted cash flow (DCF) analysis:
Feel free to download the spreadsheet and enter in your own assumptions!
I set revenue to continue growing at a mid-teens rate for the next two years. Like I mentioned before, the large backlog provides some visibility near-term. There is also the inorganic growth from recent larger acquisitions. Revenue growth moves to 5% after this high growth period to give space in case there is an air pocket in demand. EBIT margin is at 8%, which sounds low, but it is actually high for FIX and for the construction industry peers. FIX does not appear to add back amortization from acquired intangibles, so “true” EBIT margin is probably higher. I set EBIT margin to increase to 10% over time. My estimated value/share comes out to $215.
Interestingly, FIX is getting a 28X forward P/E multiple (+1 standard deviation above the 20-year mean) today despite it being a “good time” for the business. Historically, the P/E went higher during down years, while being lower during good years, typical of a cyclical company (see the Koyfin historical chart at the top). One would think that the time to buy FIX stock should be when it is trading at 40-50X on depressed earnings. FIX’s 28X multiple is also one of the highest of its peer group. I am concerned this could impact future returns.
FIX stock could have near-term upside given the recent breakout with momentum traders continuing to jump in. The stock is up 1,000% since the bottom of the pandemic, so I am sure every 100% increase in the price have led some investors to think it has gone too far too fast! I am thinking a 20X multiple on $11.50 of EPS makes more sense to me as a target price.
Combining my valuation and pricing, I get a buy-below price of $223 compared to today’s price which is now exceeding $300/share.
Risks
My main concern would be if there was an air pocket of demand due to a data center / AI / semiconductor overbuild. I could be worried for nothing, but in the past, FIX’s backlog has gone up and to the right before without equating to an up and to the right stock price:
FIX stock was flat for 7 years after 2006 with drawdowns larger than that of the SPY ETF.
In addition, I have bought stocks in the construction industry (some in FIX’s peer group) before with low success. One example was Dycom DY 0.00%↑. The stock chart was great, the growth was amazing, and the story about digging cable was easy to understand. I got a decent return on the stock over 6-12 months, but it was not a good long-term holding.
The next risk would be the acquisition strategy. I included some more recent acquisitions at the end of this post. FIX’s asset turnover is down to 1.8X, slightly lower than the >2X level it was at before.
Finally, there is some customer concentration risk with the largest customer accounting for 14% of total revenue. Besides that, revenue mix appears to be well-diversified:
“Our revenue mix continues to trend towards data centers, life science, food and other manufacturing such as chip plants and battery. Those industrial customers accounted for 54% of total revenue in the first 9 months of 2023, and they are major drivers of pipeline and backlog.
Technology, which is included in industrial was 21% of our revenue in the first 9 months of 2023, a substantial increase from 13% in the prior year. Institutional markets, which include education, health care and government are also strong and represent 27% of our revenue.
The commercial sector is active, but with our changing mix, it is now a smaller part of our business at about 19% of revenue, and most of that commercial revenue is service. Year-to-date, construction was 80% of our revenue with projects for new buildings at 55%, while existing building construction was 25%.
Service revenue increased by 14% year-to-date compared to last year. Service was 20% of our total revenues with service projects providing 9% of total revenue and pure service, including hourly work, providing 11% of revenue. Service revenue continues to be about 20% of our total revenue and our service business is on track to be $1 billion of revenue for full year 2023. ” (FIX: 2023 Earnings call 3 2023 Transcript, 2023-10-27)
To conclude, Comfort Systems USA scores a 18/25 in my latest review of the company. See where it stacks up with the other companies I follow, now on Tableau!
Thank you for reading! Please share your thoughts below.
Other acquisitions:
On October 2, 2023, we acquired all of the issued and outstanding equity interests of DECCO, Inc. (“DECCO”), headquartered in Nashua, New Hampshire, for a total preliminary purchase price of $59.8 million, which included $48.8 million of cash paid on the closing date, $7.0 million in notes payable to the former owners, an earn-out that will be paid if certain financial targets are met after the acquisition date and a working capital adjustment. DECCO operates in the Northeastern United States and performs mechanical and plumbing services with specialties in piping systems, steam, power, biotechnical processes and conveying systems, in addition to turnkey tool and equipment installation, critical equipment handling services and associated maintenance and support services. As a result of the acquisition, DECCO is a wholly owned subsidiary of the Company reported in our mechanical segment.
On February 1, 2023, we acquired all of the issued and outstanding shares of capital stock of Eldeco, Inc. (“Eldeco”), headquartered in South Carolina, for a total purchase price of $74.0 million, which included $60.8 million of cash paid on the closing date, $8.0 million in notes payable to the former owners, an earn-out that will be paid if certain financial targets are met after the acquisition date and a working capital adjustment. Eldeco performs electrical design and construction services in the Southeastern region of the United States. As a result of the acquisition, Eldeco is a wholly owned subsidiary of the Company reported in our electrical segment.
On April 1, 2022, we acquired Atlantic Electric, LLC and its related subsidiary (“Atlantic”), headquartered in Charleston, South Carolina, and with operations in South Carolina and Western North Carolina, for a total purchase price of $48.1 million, which included $34.1 million of cash paid on the closing date, $5.3 million in notes payable to former owners and a working capital adjustment. Atlantic performs electrical contracting for customers in various South Carolina markets, as well as installation of airport runway lighting in the Southeast. As a result of the acquisition, Atlantic is a wholly owned subsidiary of the Company reported in our electrical segment.
Disclosure:
I do not own FIX stock. Please see my holdings disclosure located in the Google Sheets link.
Any views or opinions are my own. I do not represent a firm. I am not giving financial advice. The stocks that I write about could increase in value, lose value, or stay the same value. Investing involves risk and losses can occur. Some stocks I write about may not be appropriate for you and you should consult a professional investment advisor. Data presented is from sources I believe to be reliable. The opinions and commentary presented reflect my best judgement at this time and may include “forward-looking statements”, all of which are subject to change at any time without obligation to update them. Actual future results may be different than my expectations.
This post and the information presented are intended for informational purposes only. The views expressed herein are the author’s alone and do not constitute an offer to sell, or a recommendation to purchase, or a solicitation of an offer to buy, any security, nor a recommendation for any investment product or service. While certain information contained herein has been obtained from sources believed to be reliable, the author has not independently verified this information, and its accuracy and completeness cannot be guaranteed. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, timeliness or completeness of this information. The author assumes no liability for this information and no obligation to update the information or analysis contained herein in the future.