Comfort Systems (FIX) is not just maintaining the building installations for its clients, it is rapidly adding to the core business with a continued string of bolt-on acquisitions. The company has seen reasonable growth in recent years and improvement in earnings power, while long being valued at very reasonable multiples.
Shares have been on a tear in 2021; however, the momentum in the share price was not accompanied by improved operational results, creating a not-so compelling set-up here.
Installation & Provider
Comfort Systems does as the name suggests, with the company being a leading national mechanical electric and plumbing installation and service provider. The company is active across more than 150 locations across the country, although somewhat overrepresented in the Eastern states of the US.
The company generates roughly $3 billion in revenues providing these services, with a strong focus on the industrial market, responsible for nearly half of sales. Other and smaller sectors include education, office buildings, governments, healthcare and retail, among others.
In terms of the stage of the activities, the company focuses heavily on new construction, responsible for just over a third of sales. Another third comes from existing buildings, with modular construction and service projects being smaller contributors as well.
A greater focus on service, indoor air quality (related to the pandemic), modular buildings, etc. has been driving demand behind the company’s solutions, but in all honesty it has been M&A which has been the key driver behind the growth reported in recent years.
Where Do We Come From?
To see where Comfort is coming from, I go back to early 2020, as the company posted its 2019 results just ahead of the pandemic. The company posted sales of $2.62 billion in 2019, up 20% on the year, on the back of strong momentum and dealmaking.
Operating earnings rose modestly in absolute dollar terms, but fell 60 basis points to 6.3% of sales, equivalent to $163 million. The company posted net earnings of $3.08 per share, as leverage was still very much under control at less than 1 times EBITDA with some deals being paid for through modest dilution.
If we look at the business, the earnings power and the balance sheet, the valuations looked quite reasonable as shares of Comfort traded around the $45 mark before the outbreak of the pandemic. In fact, shares of the company have become a bit cheaper over time as they have been trading rangebound between $40 and $60 per share since 2018 already.
Hungry For More
Amidst the outbreak of the pandemic, Comfort announced a substantial deal as it reached a deal to acquire TAS Energy in March 2020, in a deal set to add between $170 and $190 million in sales, while contributing between $15 and $17 million in EBITDA. As is typically the case, Comfort released no purchase price information at the time of the announcement.
The company furthermore reached another agreement as it acquired the Tennessee Electric Company at the start of 2021. This deal adds some $90-$100 million in revenues and $8-$9 million in EBITDA, with again no financial details being announced on the purchase.
In February 2021, the company posted its 2020 results with revenues up more than 9% to $2.86 billion, driven by dealmaking and organic growth. Operating margins improved 40 basis points again to 6.7%, as this triggered a huge increase in earnings, with reported earnings per share up a dollar to $4.09 per share. Shares rallied to the $60 mark at the time, still translating into very modest valuations at 15 times earnings, while leverage was still far below the 1 times EBITDA mark.
The company has been very active with M&A over the past year. In June, Comfort reached a deal to acquire Amteck, another electrical contracting solutions business, set to add another $175-$200 million in revenues, with the EBITDA contribution pegged at $14-$17 million, as again no purchase price details have been reported.
In October, the company posted its third quarter results as the deal with Amteck had already closed during the quarter. Revenues for the first nine months of the year were up less than 3%, despite continued dealmaking, albeit that a 16% increase in third quarter sales has been very good. Despite the modest sales growth, earnings were flattish as the company has seen a bit of margin pressure, amidst tight labor markets, among others. Net debt has risen to $206 million as EBITDA came in at $188 million the first three quarters of the year, making a run rate of a quarter of a billion likely, resulting in just a 0.8 times leverage ratio.
Current Valuation
Despite somewhat cooling momentum on the operational front, shares have run from $60 at the start of the year to $97 currently, as shares have already briefly traded above the hundred mark. With 36.5 million shares equity of the company is valued at $3.55 billion, or $3.75 billion if we include net debt. This values the operations at around 1.2-1.3 times sales and with earnings trending at $4 per share, the multiple has risen to 24 times here, after trading at a very reasonable 15 times multiple at the start of 2021.
More deals came towards the end of the year. On the first day of December, Comfort acquired Ivey Mechanical Company in a deal set to add $150-$160 million in sales and $7-$9 million in adjusted EBITDA. This deal will boost pro forma earnings by another 3%, as there is still sufficient financial room to pursue this dealmaking. Comfort announced another bolt-on deal at the outset of 2022 with the purchase of Edwards, in a deal set to add $85-$95 million in sales and $6-$8 million in EBITDA, as well as the purchase of Thermal Service LLC, in a deal set to add another $20 million in revenues.
These deals will boost pro forma sales by nearly 10%, which is comforting heading into 2022. Depending on the operating performance, I think earnings could trend between $4.50 and $5.00 per share in the coming year as margins are stabilizing and deals start to contribute, while leverage is still very reasonable.
Concluding Thought
Truth be told is that I found the shares look quite reasonable at the outset of 2021, yet shares have been seeing a great run higher as they rose more than 60%, while the company has seen stability in terms of the operating performance. This resulted in substantial valuation multiple inflation, as this set-up does not look very compelling, albeit that the company continues to pursue bolt-on deals which looks interesting.
Nonetheless, the valuation has become too demanding here, as I am not convinced of the organic growth of the business and the margin performance, making me a bit cautious here, although the continued acquisition activity is interesting to keep an eye on.