EMCOR Group: Cheap, Boring and a Long-Term Buy

EMCOR Group (EME) maintains and installs electrical and mechanical systems in the private and public sectors. According to EMCOR, the company gives “life to new structures and sustains life in existing ones by its planning, installing, operating and maintaining the sophisticated systems that create facility environments—such as electrical, mechanical, lighting, heating, security, communications and power generation systems—in virtually every sector of the economy and for a diverse range of businesses around the world.” Shares have traded between $18.20 and $38.70 over the past year, and currently trade for $22.43.

Backlog Growth

In 2007, backlog increased from $3.5B to $4.49B. The backlog grew 28.4 percent, and organic growth (excluding backlog gains via acquisition) was 23.8 percent. 53 percent of the backlog corresponds to contracts within the recession-resistant healthcare, transportation, industrial, water, and institutional segments. 47 percent of the backlog corresponds to contracts in the commercial and hospitality segments.

Growth Areas

In 2007, the facilities services segment was responsible for just under one-fifth of EMCOR’s revenues. The current trend of businesses outsourcing the maintenance and operations of system-rich facilities (so that those businesses can focus on their core business operations) has contributed to strong growth in EMCOR’s services segment, and should continue to drive revenue growth. Total service work (more than just facilities service segment) is projected to be 35 percent of total revenue in 2008 compared to 25 percent in 2003. In particular, EMCOR has identified its mobile service division as a growth field. The mobile service division is responsible for remotely monitoring and operating critical energy systems for clients.

EMCOR has also gained exposure to the energy and healthcare markets. In September 2007, EMCOR acquired Ohmstede (then a private company) for $455M. According to EMCOR:

Ohmstede is the leading provider of aftermarket maintenance and repair services, replacement parts and fabrication services for highly engineered mission-critical heat exchangers for the refinery and petrochemical industries.

Recently, Ohmstede built the largest heat exchanger device in its history for Exxon. Ohmstede is expected to contribute $280M in revenue in 2008 at a higher operating margin than the rest of EMCOR. Ohmstede is expected to add 10 cents to 2008 earnings, and more in the future. On an earnings basis, it appears that EMCOR acquired Ohmstede at a significant premium ($455M for $7M earnings this year), but Ohmstede has better margins and growth prospects than base EMCOR, and may be more profitable on a cash flow basis (EMCOR’s CEO Frank MacInnis says Ohmstede provides “strong cash flow generation”). On the healthcare front, EMCOR’s contracts within the healthcare arena have grown to 14 percent of the backlog.

In 2007, Canada was also a growth area, as revenue from Canada increased 28 percent. EMCOR lost $13M in the UK in 2007, but the company is reviewing their options for their UK operations, and we may see losses shrink as the company pares certain high-loss UK operations.

Financials

EMCOR has a market cap of $1.46B. The company has $251M cash and $223M debt. Thus, the enterprise value is $1.43B. EMCOR’s revenue has grown from $4.6B in 2005 to $4.9B in 2006 to $5.9B in 2007. 4Q 2007 revenue was a record $1.77B. Revenue is expected to increase to $6.4B in 2008. EMCOR’s earnings have more than doubled since 2005, rising to $124M for 2007. EMCOR posted a very strong 4Q 2007, earning $50M even as fears of recession took hold (see conference call transcript). EMCOR is in a low-margin business, but margins should expand due to mobile service growth and the integration of Ohmstede.

EMCOR is much more profitable from a cash flow perspective. In 2007, EMCOR generated $259M of operating cash flow and $238M of free cash flow. In 4Q 2007, EMCOR generated $119M in free cash flow. EMCOR’s service agreements (up-front payments) cause earnings to lag cash flow. Low capital expenditures also contribute to high free cash flow.

EMCOR’s three-year financial performance is below (all numbers in millions):

Conclusion

There’s nothing sexy about EMCOR, but the company’s adherence to fundamentals is laudable. The company has posted solid growth in free cash flow over the past several years and now trades at a price of 6 times trailing free cash flow even after Ohmstede acquisition costs in Q3 2007. Meanwhile, management has made strategic moves to protect against an economic downturn by expanding into the high-growth or more recession-resistant industries of energy and healthcare services. This strategy adjustment, along with the company’s strong recent results in its core markets, show that significantly worse economic conditions will have to take hold before EMCOR’s bottom line is affected. Buy EMCOR for its strong cash flow generation.

Key Stats

• Enterprise Value: $1.43B
• Trailing Operating Cash Flow: $259M
• Trailing Free Cash Flow: $238M
• Trailing Earnings: $124M

Disclosure: Author has a long position in EME