Long-term shareholders of Comfort Systems USA Inc. (FIX, Financial) have enjoyed a great return over the past decade. The company's share price has climbed by more than 1,940% since 2014, from $15 to $307 as of the time of writing, which translated into a staggering 36.30% compounded annual return, more than 10 times the S&P 500's return of merely 2.30%. Since the beginning of the year, Comfort Systems has jumped by nearly 50%. Although it has growing operating performance, my analysis shows the company is currently overvalued.
Business overview
Comfort Systems focuses on mechanical and electrical contract services, such as building, installing and maintaining mechanical, electrical and plumbing systems in 172 locations in 131 U.S. cities. The business has two main revenue streams: the installation services of the new facilities, which comprised nearly 55% of the total revenue, and the repair, renovation and maintenance services of the existing buildings, accounting for the remaining 45% of sales. Comfort Systems has a lot of projects with diverse customer base. Its top customers accounted for 14% of the total 2023 revenue. Its top customers alone generated 14% of the entire revenue for the year 2023. Comfort Systems had 10,500 projects valued at $12 billion by the end of 2023; the average contract price was $1.10 million per contract.
Growing revenue, improving operating margin and ROIC
Comfort Systems saw its operating performance grow over the past decade. The total revenue increased from $1.36 billion in 2013 to $5.20 billion in 2023. The operating income also surged from $45.70 million by more than nine times to $416 million over the same period. The operating margin soared from 3.36% to 8%. This indicates the company has improved its operating efficiencies to deliver better profitability over the past 10 years.
Part of Comfort Systems' growth strategy is mergers and acquisitions. Since 2009, it had successfully completed 21 acquisitions. In February, the company bought 100% stakes in Summit Industrial Construction, a specialty industrial contractor, and J & S Mechanical Contractors, a mechanical construction service focusing on the data center of HVAC systems and hospital medical gas systems. The two companies are expected to generate an additional $520 million to $560 million in annualized revenue, representing more than 10% of 2023 revenue. The increasing operating margin, return on invested capital and the fast-growing free cash flow are the proof its acquisitions are generating significant value for the company.
In addition to increasing revenue, the growth in the operating income and the improving operating margin, Comfort Systems also enhanced the company's investing efficiencies. Despite the large fluctuations in the return on invested capital, it gradually improves with time. Following 6.92% recorded in 2013, its ROIC peaked at 15.48% in 2018. In 2023, its ROIC settled at a fair 14.44%.
Strong cash flow generation
Comfort Systems has been generating growing cash flow. Its operating cash flow rose from $38.40 million in 2013 to nearly $640 million in 2023, while the free cash flow skyrocketed by 26 times, from $21 million to $544.70 million, over the same period. I am impressed with the free cash flow compounded annual growth of nearly 38.50% over the past 10 years.
Solid balance sheet
As of December 2023, Comfort Systems recorded $1.28 billion in shareholders equity, along with the $205 million in cash and cash equivalents. The company just uses a little debt for its operations, coming in at only $44.20 million. However, the company recorded $212.60 million in operating leases of facilities, vehicles and equipment. Thus, its net debt position stayed at nearly $52 million.
The company's debt and lease obligations spread out over the years. In the period of 2024 to 2028, the annual operating lease payment ranges from $22.50 million to $35.60 million. In my opinion, with the current cash on hand and significant free cash flow generation, Comfort Systems is quite comfortable with these debt and lease obligations.
Source: Comfort Systems' 10-K filing
The two biggest items on the balance sheet are billed accounts receivables at $1.32 billion and goodwill and intangible assets of $947.40 million. The high amount of goodwill and intangible assets are inevitable as Comfort Systems has made a series of acquisitions for business expansion over the years. The goodwill recorded on the balance sheet is the excess of the purchase price over the fair value of the acquired businesses, and the intangible assets are assets which are often included in the acquired businesses. Those goodwill and intangible assets are subject to potential impairment, if Comfort Systems determines that the acquired businesses do not perform as expected. However, with the improving margin, ROIC and growing free cash flow, I think the goodwill and intangible asset impairment is a low-probability event.
Overvaluation
Comfort Systems is trading at 18.60 times its operating income, higher than its 10-year average earnings multiple of nearly 15. In the past decade, its enterprise value-to-Ebit ratio has been quite volatile, fluctuating in the range of 8.70 to 23.12. Thus, Comfort Systems can be considered relatively overvalued compared to its historical earnings valuation.
Analysts expect the company to generate around $7 billion in revenue by 2025. If we assume Comfort Systems is able to maintain the operating margin of 8%, its operating profit would come in at $560 million in 2025. With operating earnings multiple of 15, equivalent to the 10-year average earnings multiple, its enterprise value should be $8.40 billion. Assuming the cash and debt level are equal to each other, its equity value will be the same with enterprise value. With the total shares outstanding of 35.9 million, each Comfort Systems' share should be valued at $234 per share, 24% lower than the current trading price.
Minimal dividend and share repurchase yield
Comfort Systems has been paying out consistently increasing dividends to shareholders. Its dividend per share has increased from 21 cents to 85 cents in the past 10 years. However, the dividend payout ratio has been quite minimal, fluctuating between 0.08 and 0.37. In 2023, the company only paid out 10% of its profits in dividends. With only an 85 cents per share dividend, the dividend yield is super low at only 0.28%. It is capable of increasing dividend payments to shareholders. If the dividend payout ratio reaches 0.50, the 2023 dividend per share should have been $4.25 per share, giving shareholders a dividend yield of 1.38%.
In addition to dividend payment, the company has also been buying back shares to return cash to shareholders. In 2023, it bought back nearly 139,500 shares for an average price of $152.75 per share, with the total repurchase value of $21.40 million. This represents a buyback yield of only 0.20%. As the stock is in overvalued territory, I do not think the company should spend money to repurchase its shares at the moment.
Conclusion
Comfort Systems can be seen as a long-term compounder for shareholders. The business has been growing nicely, with increasing revenue, operating profits and free cash flow. The decent operating performance is the proof that its acquisition strategy has been working well. The business is getting more and more efficient with improving operating margins and ROIC, generating significant value for shareholders. While the company has been paying dividends and buying back shares, the amount of dividend payments and share repurchases have not been enticing enough for income investors. In addition, based on my analysis, the company has been overvalued at the current trading price. Thus, investors should wait for a better price point before initiating a long position.
