Comfort Systems USA, Inc. (NYSE:FIX) operates a diversified business model with stable sales growth and EBITDA margins. In my view, the current financial situation would allow further acquisitions and perhaps internationalization. If we also add potential operating efficiencies from the company’s announced best practices and the current backlog, in my view, the stock appears to be a buy. Yes, there are some risks from failed forecasts in the estimation of projects, but the current stock price appears too low.
At over 140 locations across the United States, Comfort Systems sells heating, ventilation, air conditioning, and electrical contracting services. The company serves customers from many different industries and sectors, which, in my view, may make the revenue growth less volatile.
After the most recent quarterly release, sector diversification is not the only reason to study Comfort Systems. The company reported same-store revenue growth of over 24% due to higher costs in materials and strong markets. In my view, if management continues to plan and execute successfully, I don’t see why revenue growth wouldn’t continue going north.
We are happy to report a remarkably strong second quarter. Unprecedented market conditions resulted in same-store revenue growth of over 24%, driven by increased activity due to strong markets as well as the effect of cost increases in materials, equipment, and other inputs. Thanks to careful planning and superb execution, our teams continue their strong performance for our customers and stakeholders. Source: Press Release
The words from management about future continued strong earnings and cash flow in the coming quarters are also worth noting. Let’s also note that Comfort Systems saw an increase in its backlog from $1 billion in 2018 to more than $2.8 billion in 2022.
Although conditions are hard to predict in the near term, we are reassured by the fact that we have an expert and committed workforce, and as a result, we anticipate continued strong earnings and cash flow in the coming quarters. Source: Press Release
Considering the industry in which Comfort operates, I expected to find a lot of recurrent services. In 2022, services calls, maintenance, and monitoring represented 13% of the total amount of revenue. In my view, if the company tries to sign more agreements, including recurring revenue, more investors will be interested in Comfort.
In my view, the expectations of other financial advisors are beneficial. They expect some deceleration of sales growth in 2023 and 2024. However, the EBITDA margin is expected to remain stable at close to 8%, with an operating margin close to 5%-6%. The net income would exceed $201 million in 2022, 2023, and 2024. The level of profit is expected to be significantly higher than that in the last four years.
The investors making financial models may also appreciate Comfort Systems because of the expectations for free cash flow. The FCF/Sales margin is expected to be close to 5%-6% with capital expenditures/sales around 0.8% and 0.7%. I used some of these figures in my DCF models.
As of June 30, 2022, the company reported $69 million in cash, total assets worth $2.43 billion, and billed accounts receivable worth $942 million. In my opinion, we could expect future sales growth as clients pay for the services Comfort offers. Finally, with an asset/liability ratio over 1x, I believe that the financial situation is in good shape.
The long-term debt is equal to $403 million, which I don’t think represents a significant amount of debt. Keep in mind that I am expecting 2028 EBITDA close to $400 million, and the backlog exceeds $2.8 billion.
Management has know-how accumulated in the past as well as design and build expertise, which will enhance future revenue growth. I also believe that, under normal conditions, Comfort Systems will successfully offer customer service and will execute cost tracking.
Besides, recently, the company noted that operating efficiencies will most likely appear thanks to pricing strategies and job loop improvements among other techniques. Efficiencies could enhance EBITDA margins in the coming years and push the company’s fair valuation up.
We think we can achieve operating efficiencies and cost savings through purchasing economies, adopting “best practices,” and focusing on efficient job management. We are continually improving the “job loop” at our locations-qualifying, estimating, pricing, and executing projects effectively and efficiently. We also use our combined spend to gain purchasing advantages on products and services such as MEP components, raw materials, services, vehicles, bonding, insurance, and employee benefits. Source: 10-K
Finally, I would be assuming that Comfort’s efforts for identifying new technologies will most likely bring further productivity and customer satisfaction. As a result, I believe that Comfort Systems will likely see its sales grow at close to the growth rate seen in the past:
We work to identify, develop, and implement new materials, products and methods that can achieve greater productivity and more efficient and sustainable outcomes. Above all, we have concluded that as technology develops in our industry the fundamental prerequisite for leadership is adopting such opportunities in the quality, accuracy, and buildability of our designs. Source: 10-K
Under this case scenario, my assumptions included sales growth around 7% and 4% from 2023 to 2029 and -5% in 2030. I also included an EBITDA margin close to 7% and 9.2% along with operating margin around 6%. Subtracting small changes in working capital, D&A around $82 million, and $101 million, 2031 FCF would stand at $293 million.
Now, if we also include a discount of 9.35% and an exit multiple of 13x, the enterprise value implied would be $4.1 billion. Taking into consideration cash in hand of $69 million and debt of -$405 million, the equity would be $3.8 billion. Finally, the implied fair price would be $107 per share.
Author’s DCF Model
Comfort Systems makes a lot of assumptions when management signs new contracts. Projected costs, prices, salaries, and availability of raw materials are among the company’s most relevant assumptions. If engineers fail to forecast future economic conditions or opex related to the projects, in my view, free cash flow expectations would decline. As a result, as soon as equity researchers assess the company’s future economic performance, in my opinion, the stock price would fall.
Our contract prices are established largely based on estimates and assumptions of our projected costs, including assumptions about: future economic conditions; prices, including commodity prices; availability of labor, including the costs of providing labor, equipment, and materials; and other factors outside our control. If our estimates or assumptions prove to be inaccurate, circumstances change in a way that renders our assumptions and estimates inaccurate or we fail to successfully execute the work, cost overruns may occur, and we could experience reduced profits or a loss for affected projects. Source: 10-K
In the company’s documents, I also identified several warnings with respect to the company’s backlog. Comfort does not guarantee that backlog will be converted into revenue. Project cancellation and modification of projects could occur, which would lead to a deterioration of Comfort’s free cash flow.
The predictive value of backlog information is limited to indications of general revenue direction over the near term, and we cannot guarantee that the revenue projected from our backlog will be realized or, if realized, will be profitable. Projects may remain in our backlog for an extended period of time, or project cancellations or scope adjustments may occur with respect to contracts reflected in our backlog. Such changes may adversely affect the revenues and profit we ultimately realize on these projects. Source: 10-K
Under detrimental conditions, I believe that a WACC of 10%, 2030 sales growth of -15%, and exit multiple of 10x could make sense. I also included an EBITDA margin of around 8.5%-5.5%, which implied a 2030 EBIAT of almost $150 million. Finally, with conservative changes in working capital, capex, and D&A, the FCF would stay between $225 million and $160 million. My results include an enterprise value of $2.655 billion, equity valuation of $2.3 billion, and a fair price of $65 per share.
Author’s DCF Model
Comfort Systems acquires many other competitors all over the country. The company has a lot of expertise in the M&A markets. With this in mind, we can discard that the company’s M&A activities could accelerate, which would bring significant revenue growth. If economies of scale also appear from the acquisitions, we could also see free cash flow margin increases.
Additionally, we completed an immaterial acquisition of a mechanical contractor in Utah, which reports as a separate operating location. In the third quarter of 2021, we completed the acquisition of Amteck Holdco LLC. In the fourth quarter of 2021, we completed the acquisitions of Ivey Mechanical Company, LLC, MEP Holding Co., Inc., and a temporary staffing company in Indiana. Source: 10-K
Under this case scenario, I also assumed that Comfort Systems would try to acquire businesses outside the United States. In my view, with know-how accumulated in the U.S., management could make a good amount of dollars in Europe and perhaps Asia.
I believe that sales growth of 25% in 2023 and 15% from 2024 to 2028 could happen. I also assumed an EBITDA margin around 8.5% and effective tax of 22%, which would imply free cash flow around $455 million and $345 million from 2026 to 2030. The free cash flow margin would stand at 5%-6.5%, and with an exit multiple of 15x, the equity valuation would be $5.35 billion. Finally, the fair price could be $150 per share.
Author’s DCF Model
Comfort Systems seems to be an established business model with stable sales growth and decent margins. In my view, the current state of the balance sheet and the total amount of debt would allow many more acquisitions in the U.S. and perhaps in other territories. If I also take into account potential economies of scale, new innovative technology, and operating efficiencies, future free cash flow could grow from its current level. Even considering risks from failed forecasts or a decrease in the backlog, in my view, the current market price could certainly increase.
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Disclosure: I/we have a beneficial long position in the shares of FIX either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.