Comfort Systems USA Inc. (FIX)
At the cusp of a data center revolution
Summary
FIX 0.00%↑ is a leading specialty contractor in the US which helps industrial, commercial and institutional customers install HVAC and MEP systems. FIX is a huge beneficiary of longer-term reshoring, as well as near-term robust appetite for data center (DC) capex. I expect these tailwinds to continue through 2026 as a result of aggressive capex spending and imminent rate cuts which will likely revive non-residential capex appetite, which will likely result in increased operating leverage in future quarters. This should translate to 22% revenue CAGR with ~100bps+ of adj. EBITDA margin expansion from 9.6% in 2023 to 10.7% in 2026. FIX should make ~$19 EPS in 2026 and the stock should trade at 22x NTM PE (in line with historical regression), which implies a ~$420 stock by EOY 2025 (28%+ upside, 18% IRR).
Note: Tactically, the stock and valuation seems a little stretched into earnings given the recent cyclical rotation. I believe buyside expectations are full into 2Q24 considering management’s bullish comments during the quarter (1Q24 earnings were stellar and yet the stock fell). We would probably need to see a meaningful upward revision in guidance for the stock to pop in 2Q24.
Business description
FIX is a leading contractor for HVAC (heating ventilation air conditioning) and MEP (mechanical, electrical, plumbing) systems mainly for industrial, commercial and institutional buildings. They purchase HVAC and MEP equipment from OEMs, and then provide craft labor to help end customers install them in their buildings.
FIX operates under two segments:
Mechanical (76% of sales, 19% GPM): installation of HVAC, plumbing, piping and controls, off-site construction, monitoring and fire protection. Mechanical systems generally require ongoing maintenance and monitoring. This segment also includes the modular business which makes up ~18% of total revenues. Modular construction refers to the process where a building is constructed offsite using controlled factory conditions before being transported and assembled at the final construction site.
Electrical (24% of sales, 19% GPM): installation and servicing of electrical systems. This segment includes a greater proportion of service revenues and has higher margins.
FIX is a beneficiary of several secular growth trends:
Tight craft labor supply: there is a structural undersupply of craft labor in the US because (1) there is a dwindling proportion of individuals aspiring to be blue-collar construction workers in the US; and (2) it takes a long time to achieve the optimal experience and efficiency level for a journeyman.
Reshoring: US construction market is expected to enjoy robust growth on the back of reindustrialization, supported by policy tailwinds (IRA, IIJA, CHIPS, Trump’s infrastructure bill should he be re-elected). A Trump presidency would pose limited risks given his supportive stance towards American manufacturing.
Increasing popularity of modular construction: modular construction refers to the process where a building is prefabricated in a factory before being transported and assembled at the construction site. This improves efficiency and quality, and could deliver 10-30% savings compared to onsite construction primarily driven by lower labor costs. There is also greater assurance that systems are assembled properly as they can be tested in factories before being shipped to the construction site.
Specific to DCs, the shift to liquid cooling is a tailwind because these infrastructures are inherently more complex compared to traditional air cooling. FIX has always worked on liquid cooling construction with Google.
From a cyclical standpoint, FIX is at the cusp of a DC revolution in the US and is a key company responsible for the successful buildout of DCs. We explore this below.
Quick industry background
First and foremost, contracting is very much a local business, which makes geographic coverage important as these industrial and commercial structures are generally found outside of metropolitan cities. It is also very relationship-driven — there is very little reason for customers to switch contractors who have served them well in the past.
There are generally two types of construction delivery methods:
Plan and spec: this type of delivery method is focused on price as plans are generally put on the street to be bid. Customers generally go for the cheapest reliable contractor. Scale matters here because larger contractors naturally can reap better economies of scale and have a greater propensity to pass on cost savings to customers.
Design build: this type of delivery method is generally used for more mission-critical work where speed and quality are of essence (e.g., DCs, chip fabs, pharmaceuticals). Reputation and customer relationships matter most here because customers go for reliable partners they can trust rather than skim on price. Contractors with strong customer relationships can constantly win projects as they do not usually go up for bidding.
In essence, FIX operates in a fragmented industry where price, service quality, geographic coverage and strong customer relationships ultimately win. Compared to its largest peer (Emcor EME 0.00%↑), FIX is relatively well-positioned because it hires non-unionized labor.
M&A has been a core strategy to achieve scale and expand geographic coverage. FIX has acquired 21 companies over the last decade and the track record is spectacular, mostly exhibited by the limited margin impact on the business and improving ROIC. Margins are also consistently higher than its peers as FIX employs a decentralized model, thus facilitating labor flexibility and minimizing integration issues.
As one of the largest specialty contractors in the US with extensive geographic coverage, I believe FIX is very well-positioned to compound its growth organically and inorganically in future.
1. Tremendous growth through 2026 due to robust DC capex appetite
The proliferation of AI has led to an arms race between the Big Tech firms, as well as significant demand inflection from colocation demand as corporates attempt to leverage AI to improve their businesses. Hyperscalers and colocators have invested heavily over the past two years, and have signaled that they will continue these heavy investments through 2025. Read throughs from upstream companies support this narrative: Nvidia’s NVDA 0.00%↑ chip sales volumes are only expected to peak in 2027; SuperMicro’s SMCI 0.00%↑ AI server sales are expected to grow >30% through 2027.
Proxy construction data suggests that the bulk of this demand is fresh demand (rather than replacement demand): (1) DC companies are enjoying significant rental income growth after a period of stagnation and (2) DC vacancy rates are now at record lows as capacity is being snapped up. Some colocators are even snapping up excess Bitcoin mining capacity to meet robust demand (e.g., CoreWeave is even purchasing extra real estate from Bitcoin mining firm Core Scientific CORZ 0.00%↑ to meet robust demand).
Renowned real estate firms (Cushman & Wakefield, CBRE, JLL) forecasts DC supply in the US to increase ~5GW in 2025 and ~7-8GW in 2026. This translates to a cumulative ~$120-130bn capex through 2026, with more than half of which being paid to construction companies (the cost of building an average DC in the US amounts to ~$10m per MW) as electrical infrastructure and HVAC / mechanical infrastructure make up 40-45% and 15-20% of the total cost respectively. Clearly, this growth runway extends well into 2026.
FIX has been a huge beneficiary of accelerated DC buildouts since 2022. Technology customers traditionally represented low teens % of total revenue and now represent 30% of revenue in 1Q24; and is growing >100% y/y. This is further evidenced by new construction revenue inflecting since 2022.
Additionally, there are several indications that FIX is likely enjoying price tailwinds as demand outstrips supply. First, FIX has traditionally had a diverse customer base with most individual customers accounting for <3% of consolidated revenues. However, the company started reporting some concentration risk in their 10K since 2019. FIX’s top customer (most likely Google) now accounts for 14% of consolidated revenues, up from 5% in 2019 and 8% in 2022.
Second, management has hinted that they are seeing healthy pricing overall, most notably from tech customers. CFO commentary in 1Q24 reaffirms this conclusion — top customers have been paying top dollar and are willing to continue buying all of FIX’s capacity in the modular business. This facilitates further gross margin expansion given that modular remains margin dilutive due to its smaller scale (EBIT margins are similar due to limited SG&A for the modular business).
1Q24 CFO: “As far as diversifying the thing that keeps us from diversifying is that fantastic customers are willing to buy all of our capacity… They've asked us, what do we need to do to have all of your capacity? And we said, well, this would be what you need to do, and they've done it. And they've asked us if -- last year, they said, what do you need in order to expand your capacity? And we said, look, for to be fair to our shareholders and the risks that we take and the cost we did incur, we need these kind of commitments and they made them. And so we're keeping our commitments to them.”
Based on the robust demand data above and conversations with the management, it seems like things are not slowing down for FIX. Management noted that demand is looking as good as (if not better) as last earnings. There is little to no bidding going in the market today, and projects are getting so complex that FIX is brought in from the start and they are winning contracts 90-100% of the time. Current backlog lead times have also increased from 6 months traditionally to ~12 months at the moment. With a record (and growing) ~$6bn backlog and 30% of it extending through 2025, it is difficult to imagine a scenario where FIX’s growth decelerates significantly in the next two years.
2. Significant operating leverage driven by robust demand and modular growth
FIX has historically enjoyed significant operating leverage over the long-term as demonstrated by consistent EBIT margin expansion and strong incrementals. In light of the unprecedented surge in demand, I believe margin still has room for expansion in future quarters.
FIX’s historical seasonality paints a similar narrative. 1Q has traditionally been the weakest quarter due to lower economic activity during the winter. As seen below, FIX has never had a seasonally weaker quarter after 1Q in the company’s history. Meanwhile, 1Q24 results were off the charts due to the reasons discussed above — Electrical gross margins +470bps y/y, adj. EBITDA on a same-store basis +70% y/y, adj. EBITDA margins +340bps y/y.
Assuming historical seasonality holds, I foresee FIX smashing sell-side estimates. It is noteworthy to mention that management has always been very conservative in the past and I believe this year is no different. In fact, CEO’s extremely bullish comments and confidence during the 1Q24 earnings pretty much guided a strong 2Q24.
1Q24: “We don't know what's going to happen, but these margins are for a first quarter. They are extraordinary. Now do I think we've got extraordinary margins in our future? I do. But on a comparable basis, it's a tough comparable. If we were about to hit tough comparables from the prior year, then our first quarter was comparable for the ages. But we're about to make a lot of money. We'll go for it. Yes, we'll make as much money as we can, and you can figure out what that means.”
Some skeptics might be concerned about the weaker commercial segment given the weak macro indicators recently. However, only ~20% of the business is tied to this segment and most of that is service revenue, which explains the bifurcation between FIX’s business momentum and commonly used macro indicators like ABI.
Longer-term growth should be supported by increased non-residential capex appetite in light of imminent rate cuts. In addition to DCs, FIX has strong exposure to chip plants and pharma end markets. Management has noted that FIX is working on 5 out of 7 of the major chip plants being built in the US, and there is a sustained onshoring trend in pharma which is long-cycle. Putting things into context, FIX has traditionally been a business that has grown at low teens CAGR in the past (MSD % organic + MSD % acquisitions) despite offshoring which was a 2-5% headwind to organic growth. Obviously, the tide has turned.
There should be further room for margin expansion given the potential economies of scale that FIX can reap from growing the modular business. As mentioned earlier, modular is relatively new to the overall business and enjoys multiple secular tailwinds. Management has noted that this segment remains gross margin-dilutive compared to the broader Mechanical segment due to its relatively smaller scale. However, larger scale begets higher margin, especially since modular operates like a manufacturing line (as compared to traditional contracting work in construction sites). While the lack of disclosures obscures granularity, I believe the risk of further margin dilution is low given FIX’s prudence. Management has noted that they are making their largest customers pay for additional capacity — e.g., FIX has a 3 year commitment from Google to add 1m sqft of capacity with deposits and healthy margins.
Valuation
Based on the above reasons, I believe the stock can do $19.14 EPS in 2026 and trade at 22x, implying a $421 stock by EOY 2025. Below are my assumptions:
Revenue should grow 22% CAGR through 2026 as FIX enjoys price and volume tailwinds due to (1) robust demand and (2) structural undersupply of craft labor (sellers’ market). Sell-side consensus has captured FIX’s higher growth well in 2024 figures, but seems to remain cautious on growth in 2025 and 2026. Based on my conversations with the sell-side, it seems like they are unwilling to make too aggressive calls without management’s explicit comments and are just being conservative in light of historical growth.
Management guides 18-20% gross margin (leaning towards the higher end). I don’t foresee FIX being too aggressive with pricing which might be detrimental to its customer relationships, hence I forecast gross margin to be in line with management’s guide. However, it should be at the high end of the range considering constructive comments on robust demand with nearly 100% utilization.
Adj. EBITDA margin should expand due to significant operating leverage in the following quarters, especially when we take seasonality into consideration. I forecast SG&A margin to decline from 11.0% in 2023 to 10.6% in 2026, resulting in a ~100bps increase in adj. EBITDA margin. I think an annual ~20bps+ tailwind is reasonable considering growth in the modular business and sustained robust demand through 2026, yet conservative enough given that FIX already has a margin lead vs peers Emcor (EME) and IES Holdings (IESC). This ultimately results in adj. EBITDA growing at 26% CAGR through 2026.
FIX traditionally trades on EBITDA growth expectations. The stock currently trades at 22x NTM PE, a slight premium compared to its historical valuation range. Given the strength and sustainability of current tailwinds, I believe such a premium is justified.
The main risk is that we see sharply lower DC capex appetite in 2025 and 2026, which should also result in significantly smaller operating leverage. This translates to mid-teens revenue growth (slightly above historical growth rates considering broader reshoring and near-term DC capex momentum) and ~9.3% adj. EBITDA margin in 2026, supporting $14.30 EPS in 2026. Stock should trade at ~20x NTM PE (with ~16% EBITDA growth) supporting a $286 stock price by EOY 2025 (13% downside).
Catalysts
Positive commentary on hyperscaler / colocator capex guides
Positive non-residential construction and macro data
Rate cuts
Disclaimer: All views expressed are the sole opinion of the author and should not be interpreted as investment advice. All readers should conduct independent research before making any investment decisions.