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Comfort Systems USA (NYSE:FIX) is set to benefit from long-term strong growth expectations for the global mechanical, electrical, and plumbing market through the remainder of the decade. Comfort Systems has strong growth expectations for this year and beyond. FIX is experiencing strong demand from commercial customers in key industries such as technology, which is likely to drive growth going forward. The stock is reasonably priced according to a key growth valuation metric, leaving room for price appreciation driven by FIX’s growth.
Comfort Systems USA Business Background
Comfort Systems provides mechanical and electrical installation and maintenance services for commercial and industrial settings. FIX offers HVAC systems, plumbing, electrical, construction, monitoring, and fire protection. The company designs and installs these systems for new buildings and repairs/ replaces existing systems. FIX serves various fields such as: technology, manufacturing, health care, education, retail, government, and office settings.
Comfort Systems USA operates two segments:
1. The Mechanical segment, which comprises 78% of total revenue, handles HVAC systems installation, repair, replacement, and maintenance. These systems include chillers, boilers, cooling towers, and air handlers. This segment also handles the piping and ducting associated with these systems.
2. The Electrical segment comprises 22% of total revenue and handles electrical construction and engineering in industrial and commercial settings. This segment also handles electrical logistic services and service work.
Growth Catalysts
Comfort Systems USA has multiple positive catalysts that can help drive long-term growth. A key growth catalyst for FIX is the growing technology sector. For example, the global AI (artificial intelligence) market is expected to grow about 19% annually to reach about $2.6 trillion by 2032. This strong growth creates the need for data center facilities to supply the computing power associated with AI. The projected growth for data center construction is estimated to be 10% to 20% per year to 2030. Comfort Systems is involved in designing and installing HVAC and electrical for these technology facilities. Technology comprises 30% of FIX’s total revenue. The company experienced strong growth over the past year as technology comprised only 19% of total revenue in the prior year.
Comfort Systems closed on two acquisitions in February for the Mechanical segment. One of these was Summit Industrial which has the ability to execute large scale modular programs for customers. Comfort Systems expects Summit to expand and diversify the company’s modular construction business which is seeing strong demand. Summit is expected to bring in $375 million to $400 million in annual revenue and $35 million to $40 million in annual EBITDA. That’s about 7% of FIX’s annual revenue and about 6% to 7% of FIX’s EBITDA.
The other acquisition was J&S Mechanical which provides mechanical construction services to commercial and industrial customers in the mountain west area of the United States. J&S is expected to generate $140 million to $160 million in annual revenue and $12 million to $15 million in annual EBITDA. That represents about 2.5% to 3% of FIX’s annual revenue and 2% to 2.6% of FIX’s annual EBITDA. Both acquisitions provide add-on growth for Comfort Systems.
Comfort Systems has a record backlog of $5.9 billion as of the end of Q1 2024. This is 33% or $1.5 billion higher than the backlog at the end of Q1 2023. Half of the increase was from FIX’s organic growth while the other half came from acquisitions. The current backlog is higher than the $5.2 billion in revenue that Comfort Systems generated in 2023. The growth trends that FIX is seeing for this revenue mix is for the following types of facilities: data centers, food, chip fabrication, battery plants, and life science.
Valuation
Comfort Systems looks overvalued at first glance with a forward PE ratio of 26. This is higher than the Engineering & Construction industry’s forward PE of 20.5. However, investors are probably awarding the stock with a premium valuation due to FIX’s above-average growth. As a result, I think the PEG ratio is more appropriate to value FIX since the company is experiencing strong double-digit earnings growth. In fact, consensus estimates from Comfort System’s 5 analysts are projecting the company to achieve 39% EPS growth for 2024. Consensus estimates are also projecting FIX to average 15% EPS growth over the next 3 to 5 years.
The PEG ratio is appropriate in my opinion because it takes multiple years of EPS growth into consideration. I like to use the PEG ratio for the high growth companies that I cover.
With that said, FIX is trading with a PEG ratio of 1.7. This is below the Engineering & Construction industry’s PEG of 3. The growth stocks that I cover tend to perform well when the PEG ratio is below 2, for healthy growth businesses like Comfort Systems.
The consensus estimates for 2024 although high, are still reasonable in my opinion. The reason that this strong expected growth can be achieved is due to the recent acquisitions plus FIX’s growth from existing businesses. The earnings growth can be driven by the 28% expected gain in revenue in 2024 from acquisitions plus organic growth. FIX’s strong profitability metrics such as the ROE of 30% and ROIC of about 20% are likely to drive earnings higher at a strong pace. FIX’s profitability is also getting a boost from a higher gross margin [GM]. Comfort Systems increased its GM to 19.35% in Q1 2024 over the 16.92% GM from Q1 2023. The company also improved its operating margin to 8.76% in Q1 2024 over the 5.37% from Q1 2023.
With the PEG ratio below 2, I think that the stock can reasonably increase at an above average pace due to Comfort Systems higher than average expected earnings growth. As a comparison, the S&P 500 is expected to increase earnings at 11% in 2024, while FIX is expected to grow earnings at 39%.
Technical Perspective
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Comfort Systems (FIX) Weekly Chart with RSI (TradingView)
FIX’s weekly chart above shows a recent pullback from an overbought condition (RSI above 70) that the stock was in from the end of January 2024 to the beginning of April. The stock is no longer overbought. However, the stock is still in bullish territory with the RSI above 50.
The next positive catalyst for the stock could be Comfort Systems’ Q2 earnings report scheduled for July 26, 2024 (post market). The company is expected to achieve normalized EPS of $3.14 and $1.69 billion in revenue according to consensus estimates. The stock can continue its rise if the company meets or exceeds these estimates. Also, if FIX provides positive guidance for the remainder of the year, it would likely drive the stock higher. The Q2 estimates look achievable given the strong demand that FIX is experiencing, plus the increases in margins can drive earnings higher. However, the stock could sell off if the company misses estimates or if negative guidance is given for the remainder of the year.
The announcement of new contracts or projects could have a positive impact on FIX’s stock. New large projects could drive the stock to higher highs as investors price in new sources of revenue and earnings.
Another potential positive catalyst could be a new lucrative acquisition. M&A is a part of Comfort Systems USA’s strategy. So, it is possible that another business-enhancing acquisition in the future helps drive the stock higher.
There are other risks for Comfort Systems that could lead to a decline in the stock. A slowdown in construction projects for the markets that FIX serves could have a negative impact on Comfort Systems’ revenue and earnings.
Comfort Systems could experience adjustments or cancellations of projects in its backlog. This would have a likely negative impact on FIX’s revenue and put downward pressure on the stock.
Higher inflation for the cost of Comfort Systems USA’s materials (copper, steel, PVC, etc) could squeeze the company’s margins. FIX could struggle to fully pass on higher costs to customers which could narrow margins. This could negatively impact earnings and the stock price.
Comfort Systems USA Long-Term Investment Outlook
The strong backlog, recent acquisitions, and the current trends driving growth for the construction projects that Comfort Systems handles is likely to drive the stock higher over the next year and beyond. The stock’s reasonable valuation on a PEG ratio basis can allow further gains in the stock as FIX increases revenue and earnings going forward. The company’s above-average expected growth should lead to above-average gains for the stock.
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