Comfort Systems: Still Not Too Comforting (NYSE:FIX)

Elektrotechnici testen elektrische installaties en bedrading op beschermende relais en meten ze met een multimeter.

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At the start of the year, I believed that I was not too comfortable with Comfort Systems (NYSE:FIX), despite a strong taste for continued dealmaking efforts. The company provides critical tasks for its clients, maintaining building installations, as this sound positioning, a fragmented marketplace and taste for deals creates an interesting set-up.

This is to be applauded, yet the end of 2021 and start of 2022 are likely overshadowed by inflation concerns, creating a tough set-up for shares despite a continuation of the dealmaking efforts.

The Business – The Thesis

Comfort provides mechanical electrics and plumbing installation and related services. The company is active in more than 150 locations across the US, albeit that it is overrepresented in the Eastern parts of the US.

The company generates more than $3 billion in revenues, with a strong focus on the industrial market, which is responsible for more than half of sales, as other sectors include education, office buildings, healthcare, retail and other buildings. These installation and maintenance activities are generated across the life cycle of the buildings, with a third of revenues coming from new construction, a third from maintenance of existing buildings and special projects and modular making up for the remainder of revenues.

Greater focus on service, indoor air quality (pandemic) have been drivers behind the growth, with M&A adding more growth on top of that. The business generated $2.6 billion in revenues in 2019 (up 20% on the year before), yet margins fell 60 basis point to 6.3% of sales, with earnings coming in around $3 per share. With shares trading at $45 ahead of the pandemic, having traded range bound between $40 and $60 from 2018, valuations were non-demanding.

Amidst the outbreak of the pandemic, the company announced a few deals with the purchase of TAS Energy and Tennessee Electrics, adding nearly $300 million in sales, as 2020 sales rose 9% to $2.86 billion, with operating margins rebounding to 6.7%. The combination of revenue growth and margin expansion resulted in earnings inching up to $4 per share, with shares rallying to $60 subsequently in early 2021.

Dealmaking continued through 2021 with the purchase of Amteck which added nearly $200 million in sales, as net debt remained quite controllable amidst retained earnings and reasonable purchase prices. The market has grown more appreciative of the performance over time as shares rallied to $97 in January of this year, after having touched the $100 mark already.

The company was valued at $3.75 billion, including net debt of around $200 million, equal to 24 times earnings which came in around $4 per share. This shows that the recent run higher in the share price has mostly been the result from valuation multiple inflation, never a great sign for a prospective shareholder. Part of the enthusiasm seems to relate to continued dealmaking with Comfort acquiring Ivey Mechanical in December 2021 and Edwards at the start of 2022, as the combined revenue contribution of these deals comes in at a quarter of a billion again.

With earnings power pegged at $4.50-$5.00 per share by myself, I saw the multiple drops quite quickly, but the fact that the great 2021 share advancement has mostly resulted from a re-rating of the valuation, made me a bit cautious, although I was attracted to the M&A strategy.

A Modest Retreat

In the quarter since I last looked at Comfort Systems, shares have fallen from the high nineties to $86 at the moment of writing, a roughly 10% pullback in the time frame of just three months, difficult months for the market at large.

On the corporate front, it has been relatively quiet. In February, Comfort posted its 2021 results with fourth quarter revenues up 22% to $856 million, at a run rate of around $3.4 billion, as full year sales rose a much more modest 8% to $3.1 billion. Despite the solid topline results, the company has seen margin pressure on both time frames with full year margins down 60 basis points to 6.1% of sales, as the fourth quarter saw 110 basis points of deleveraging. This made that earnings for the year were flat at $3.93 per share, actually down a bit from a >$4 per share number in 2020.

At the start of April, Comfort announced another deal with the purchase of Atlantic Electric. Founded in 1969, the company is active in the South Carolina markets, performing electrical contracting and airport runway lighting. The company is set to add $50 million in sales and $5 million in EBITDA, marking truly a bolt-on deal, adding some 1.5% to pro forma sales. As usual, no purchase price details have been announced.

What Now?

Truth be told is that Comfort finds itself on a comfort footing. The company generated $256 million in EBITDA, with the fourth quarter run rate coming in fractionally higher. Based on a $329 million net debt load by the end of 2021, leverage ratios remain reasonable at 1.3 times.

A comforting factor for the year 2022 is the fact that the backlog has risen from $1.5 billion to $2.3 billion and that multiple deals still have to annualise, and thus still contribute to 2022 growth. On the other hand, is the fact that inflationary pressures are building up, and that material availability is becoming a real concern here.

Given this backdrop, I am no longer automatically assuming earnings per share to the tune of $5 per share in 22022, but see some headwinds to that number, as the modest pullback does not automatically create great appeal just yet. Hence, I look forward with great interest to the first quarter results, but for now, still do not see a quick fix for my portfolio by taking on some Comfort at these levels.

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