Beyond a strong balance sheet, other key characteristics that we look for in our companies include a strong business model and a large addressable market to support long-term revenue and earnings compounding. Our addition of Comfort Systems USA (NYSE:FIX) is a good example of these factors. Comfort Systems offers design, installation, retrofit and service for HVAC and electrical systems for facilities such as office buildings, plants, retail centers, hospitals and universities. Comfort Systems is unique in that it focuses mostly in smaller cities where, relative to large urban settings, there is less competition for both projects and for skilled labor. The company works on approximately 4,000 jobs annually and most of the contracts are under $1 million. More than half of these are for renovations and repairs and are recurring in nature, rather than from new constructions.
The outlook for revenue growth is solid, as the aging existing HVAC stock in the U.S. should provide a good organic growth rate of approximately 3 to 5% annually over many years. We particularly like the management team's skillset in acquiring smaller competitors to add geographic coverage and achieve operational synergies. Management buys small, local competitors that earn only 2 or 3% operating margins (the margins are low in this business because they include pass-through equipment costs) and pay only 5-6X EBITDA. After overlaying Comfort Systems' buying power and operational standards, margins of the acquired companies normally double to 4-6% after a year, effectively cutting the purchase price in half. We think that a combination of a solid core business, operational leverage and large acquisition opportunities will provide higher sales and higher margins for many years. Net of cash, the company has no debt. At our purchase price of just over $28, we see solid upside to our mid-$30's estimate of fair value NAV, with a solid outlook for book value growth and a 6.2% free cash flow yield. Continue Reading »