Investment Summary:
EnviroStar, Inc. (the "Company", "EnviroStar" or "EVI") is a distributor of commercial and industrial laundry and dry-cleaning equipment. The Company has a proven long-term track record of consistently growing earnings per share. Over the past 10 years, revenues have increased by 2.6x and earnings per share has increased by 3.0x. During this period, this business consistently generated highly attractive returns on tangible capital (~25% to in excess of 85%). Furthermore, the dry cleaning and laundry business is well known for its resilience against recessions. Clothes get dirty and need to be washed. EnviroStar was profitable throughout the Great Recession and has a track record of effectively converting sales into cash.
The Company currently has a market capitalization of $21.4 MM and an enterprise value of $15.9 MM. This calculation is based on a stock price of $3.05 (as of 1/16/14), no debt and $5.5 MM of net cash (adjusts for one-time dividend paid in Dec. 2013). Note: this calculation of enterprise value assumes all cash is excess cash; based on discussions with knowledgeable investors, there is a view that approximately 50% of cash is required for working capital.
During the LTM period ending September 30, 2013, the Company generated $38.2 MM of revenue and $3.0 MM of operating income. Based on LTM results, this implies an earnings yield (EV/LTM EBIT) of 18.9%.
The Company is not covered by sell-side analysts and is thinly traded.
Further in the report, we will discuss in detail several investment insights as to why we believe the Company continues to face favorable tailwinds which will allow the Company to grow over the next 5, 10 and 20 years.
These specific investment insights include:
· The Company has a meaningful customer base which creates a significant barrier to entry for new entrants;
· Rising water and resource costs generate demand for more efficient commercial and industrial laundry equipment and steam boilers;
· Regulatory catalysts will continue to drive the commercial dry cleaning equipment upgrade cycle;
· EnviroStar is the beneficiary of long-term population density and income growth in its core markets; and,
· The Company is managed by a talented and proven family-owner/operator.
EnviroStar is a business with superb economic characteristics and is trading at reasonable valuations.
The front section of the write-up will focus on the key investment insights.
Investment Insights:
EnviroStar has consistently earned highly attractive returns on tangible capital (EBIT / (Net Working Capital (ex. Cash) + Tangible Assets)), ranging from 25% to over 85% over the past 10 year period. This is indicative of the fact that this business would be difficult to replicate given sufficient capital and talent. If this were not the case, competition would drive down these abnormally high levels of return on tangible capital.
The following insights help explain why the business possesses favorable economic and growth characteristics:
The Company has a meaningful customer base which creates a significant barrier to entry for new entrants.A virtuous cycle is created as equipment distribution businesses scale. Customers prefer to work with distributors that provide (i) sensible pricing, (ii) product quality and selection (create a one-stop-shop) and (iii) provide high quality support services. The ability to deliver on each of these three items increases with scale which thereby increases the distributors value proposition to both new and existing customers.
By having sufficient volumes and a reputation, a distributor is able to negotiate favorable terms (pricing and exclusivity) from manufactures. This either enhances profitability of the Company or the savings that can be passed on to customers. EnviroStar has relationships with major manufactures, including Pellerin Milnor Corporation, Chicago Dryer Company, Cleaver Brooks Inc., E-Tech Inc., Fulton Thermal Corp., and Unipress Corporation. Two of these manufacturers accounted for approximately 45% and 19%, respectively, of the Company's purchases for FY 2013 and FY 2012.
Maintenance, repair and service support are important value-added services. When a customer has a part break, fast servicing and repair of that machine is required to minimize lost revenue. Therefore, many customers choose to work with regional distributers that have a long standing reputation. Replacement parts and maintenance services create a meaningful recurring revenue stream, estimated to total 15%-50% of the initial product sale value. EnviroStar stores ~$2.0 MM worth of inventories, including replacement parts in its two main distribution centers (38,000 square feet) both located in Miami, Florida.
A new market entrant faces a chicken-and-the-egg problem. In order to replicate this business, the new market entrant would have to develop relationships with multiple manufactures. It would be difficult to negotiate favorable terms given that the new market entrant does not have an existing installed customer base. Therefore, it would be difficult to deliver a sufficiently compelling value proposition to customers to get them to switch distributors because the new market entrant will likely be less competitive on its ability to deliver a pricing advantage, product selection and maintenance services.
A larger strategic competitor would ask a buy-versus-build question. Given the stickiness of customers created through long-term relationships, the incumbent has a meaningful competitive advantage. Execution risk and initial upfront investments (i.e. sales force, infrastructure, logistics systems, inventory, etc.) are substantial.
As a result of this economic characteristic, it is most probable that EnviroStar will continue to build upon this natural competitive advantage in a similar fashion that it has done over the last 50+ years since its founding.
Rising water and resource costs generate demand for more efficient commercial and industrial laundry equipment.The average American household washes 400 loads of laundry each year using thousands of gallons of water.According to a survey of 100 municipalities, water prices have risen by 75% between 2000 and 2012. Electricity prices have risen by 43%. Within Miami, water costs have increased by 37% during this same period. Customers continue to move toward equipment with improved water and energy efficiency as the result of escalating energy costs, government and consumer pressure and a focus on containing operating costs. As an example, approximately 25% of annual gross wash and dry revenue of laundromats is consumed by utility costs, according to the Coin Laundry Association.
Regulatory catalysts will continue to drive the commercial dry cleaning equipment upgrade cycle. The commercial dry cleaning industry in the United States consists of approximately 36,000 shops (low range of estimates are 25,000 shops). Approximately 85% of dry cleaning shops in the U.S. use perchloroethylene ("perc") as their primary cleaning solvent. Most dry cleaners use about 140 gallons of perc a year.
Perc, which evaporates very easily into the air, is suspected of causing cancer in humans, is considered toxic, and can cause dizziness, nausea and headaches when either inhaled or absorbed through the skin. Once in the body, perc can remain stored in fat tissue. Numerous studies have shown the dangers of perc. The National Institute for Occupational Safety and Health ("NIOSH") has designated perc a "potential occupational carcinogen." The National Toxicology Program has designated it as "reasonably anticipated to be a human carcinogen." The International Agency for Research on Cancer ("IARC") has designated perc as a "probable human carcinogen." Perc that makes its way into the ground can move through the ground and enter groundwater. Plants and animals living in environments contaminated with perc can store small amounts of the chemical.
In 2007, California became the first state to ban perc use in dry cleaning. Other states are contemplating such action. The EPA ordered a phase-out of perc machines at dry cleaning shops in residential areas by 2020, but may continue to operate if alternative technologies are used (CO2, hydrocarbon, and wet cleaning).
The dry cleaning equipment distributed by EnviroStar includes commercial dry cleaning machines, most of which, including the Company's proprietary Green-Jet® dry-wetcleaning machine, are environmentally friendly because they eliminate the use of perc in the dry cleaning process.
There will be continued demand for non-perc using machines as end users are forced to comply with EPA regulations.
EnviroStar is the beneficiary of long-term population density and income growth in its core markets.
Commercial laundry and dry cleaning services deliver high value proposition in densely populated urban areas. Multi-family residential areas increase in proportion with increased population density. It is often times impossible for individual tenants to own their own washer and dryer. Furthermore, high-income earners frequently demand the value-added services of outsourcing laundry.
Therefore, the Company is a beneficiary of favorable long-term demographic growth trends. Miami (a core market to EnviroStar) is estimated to increase in population, population density and income per capita over the next five years. According to data from SNL, between 2012 through 2017, Miami's population is expected to grow from 5.6 MM to 5.8 MM (0.7% CAGR); population density is expected to increase from 1,102 people per square mile to 1,141 (0.7% CAGR); and per capita income is expected to grow from $24,920 to $27,935 (2.3% CAGR).
Laundry needs in developing markets are currently less fully developed than in North America. Continued development and growth of disposable income in these countries will cultivate an increased need and demand for laundry services and equipment. Foreign sales by the Company to the Caribbean and Latin America range between $4.0 - $5.0 MM per year. For FY 1Q'14, foreign sales increased by 70% versus FY 1Q'13.
The Company is managed by a talented family-owner/operator. The Steiner family's ability to build this business into what it is today from a standing start is admirable. Bill Steiner founded the company in 1960 and today the company has grown to $38.2 MM of LTM revenues. The Steiner family is a substantial owner. Michael Steiner (President, CEO and Chairman of the Board) owns 57.4% of shares outstanding and his brother, Robert Steiner, owns 14.4%. Lastly, Management has a track record of returning capital to shareholders through special dividends. Recent examples include a $0.40 per share special dividend paid in December 2013 and a $0.60 special dividend paid in December 2012.
Addressing The Bear Argument:
The following are arguments that the bears may make as well as insights associated to mitigants:
Commercial equipment distribution is a cyclical business. FY 2013 was a top-of-the-cycle year for EnviroStar. The stock price will decline as earnings come off cyclical highs.
Investors that run a numerical analysis based on sensible assumptions will find that as long as the long-term growth thesis remains intact, then a buy and hold strategy for this security at current valuations will result in an attractive return profile even if results for a specific year is shocked (please refer to the Appendix for a numerical example). There is precedence in the marketplace that sophisticated and long-term oriented investors will look-through business cyclicality if there is conviction regarding the long-term growth thesis because the numerical analysis demonstrates that this is a sensible action. As a great investor once said, "why should we demand that smoothness [of earnings] accompany each orbit that the earth makes of the sun?"
Lastly, a three-year average EBIT (a proxy for a normalized, mid-cycle operating income) results in a high single digit earnings yield.
EnviroStar has already had a strong recent run-up and is trading at record high valuation multiples (over a five year period).
On an EV/EBITDA basis, EnviroStar generally traded between a 1x - 3x EBITDA multiple over the past five years. Currently, the Company is trading at a 5.3x EBITDA multiple.
First, it is important to consider that asset price levels were depressed during the Great Recession. Cheap stocks got cheaper.
Second, EBITDA in FY 2008 was $924k. EBITDA then declined to $835k by FY 2012. These data points were used in the bear narrative to support the thesis that the business was in secular (versus cyclical) decline. However, results in FY 2013 as well as FY 1Q'14 demonstrate that the long-term growth thesis remains intact. Furthermore, it is likely that multiples continue to expand as the market gives full credit for the long-term growth trajectory that the Company has been able to demonstrate since its founding in 1960.
Lastly, current price levels are similar to the highs experienced by the Company in early 2005. It has taken the Company's stock almost nine years to recover to a similar price level. During that time, the Company has significantly improved its fundamentals.
Conclusion:
EnviroStar is in an ordinary business with a track record demonstrating that it is able to execute extraordinarily well. The Company's leading market position, favorable regulatory catalysts, favorable long-term demographic trends and superb management team, will allow this Company to grow over the next 5, 10 or 20 years.
Catalysts:
Attractive valuation levels (value is its own catalyst)
Growth driven by increased demand for commercial and laundry equipment resulting from (i) rising water and resource costs and (ii) regulatory catalysts and (iii) long-term population and income growth.
APPENDIX:
Business Description:
EnviroStar has two wholly-owned subsidiaries, Steiner-Atlantic Corp. ("Steiner") and DRYCLEAN USA License Corp ("Dryclean USA").
· Steiner does three things: (i) sells and distributes a broad line of commercial and industrial laundry and dry cleaning equipment, (ii) supplies maintenance parts and provides maintenance services and (iii) designs and plans "turn-key" laundry systems (for institutional and mom-and-pop shops). Specific products sold by Steiner include washers and dryers, tunnel systems, coin-operated machines, commercial dry cleaning machines and boiler products. Suggested prices for most of the Company's equipment range from approximately $5,000 to $1,000,000. The useful life of stand-alone commercial laundry equipment is generally 7 to 14 years. The products and parts sold by the Company and the maintenance services provided by the Company accounted for approximately 99% of revenues.
· DRYCLEAN USA franchises and licenses dry cleaning stores in the United States, the Caribbean and Latin America. DRYCLEAN USA has nearly 400 locations and generates approximately $200k in royalties per year.
The Company has approximately 1,700 customers in the United States (with a significant concentration in South Florida), Caribbean and Latin America. These customers include laundry plants, hotels, motels, cruise lines, hospitals, hospital combines, nursing homes, government institutions, distributors and specialized users. In FY 2003, the Company reported 500 customers, which implies a customer growth rate of 12.7% per annum.
EnviroStar is headquartered in Miami, Florida and listed on the NYSE MKT under the ticker EVI. The Company has 28 full-time employees. The Company has a fiscal year that ends June 30th.
History:
Steiner-Atlantic Corp. ("Steiner") was originally founded in 1960 by William Kalman ("Bill") Steiner. Bill was born in Chicago and held part-time jobs throughout high school and worked his way through college to earn his accounting degree. He moved to Miami in 1959. Steiner initially operated as a distributor of dry cleaning systems and boilers, and as a rebuilder of laundry, dry cleaning and boiler equipment. Steiner expanded in 1972 when it began distributing institutional laundry equipment to hotels, motels and hospitals. In 1980, Steiner began importing dry cleaning systems from an English manufacturer, and four years later, Steiner developed a relationship with an Italian manufacturer of dry cleaning systems. Michael Steiner, Bill's son, became President and CEO of the Company in 1988. In 1990, Steiner established its own branded product line with the introduction of an updated dry cleaning system under the Aero-Tech label, substantially all of which is currently manufactured exclusively for Steiner in Italy. Bill constantly sought to improve dry cleaning machinery in order to make the industry more environmentally friendly. Steiner is the holder of several patents for environmentally safe dry cleaning equipment and processes.
EnviroStar became public through a reverse merger. On November 1, 1998, Steiner was merged with Metro-Tel Corp. ("Metro-Tel"), a manufacturer and seller of telephone test and customer premise equipment. At the time, Metro-Tel was a marginally profitable business and the industry faced significant headwinds. Metro-Tel hired Slusser Associates, Inc. ("Slusser"), an investment bank, to evaluate strategic alternatives. Slusser had assisted Steiner in exploring strategic alternatives from 1994 through 1995. Metro-Tel's Board approved the merger because, according to the proxy filing, it was "unable to locate an alternative merger partner which would offer the Company and its stockholders a better opportunity for increasing stockholder value over the long-term than that of merging with Steiner." The Steiner family owned 69.0% of the Company post-merger. Based on an interview with a former major investor of the Company, the reason why EnviroStar remains a public entity, despite significant public company costs, is because it is a source of competitive strength when EnviroStar competes for business with certain larger customers.
The Company changed its name to DRYCLEAN USA, Inc. on November 7, 1999 to reflect a change in the primary nature of its consolidated operations. On July 31, 2002, the Company sold substantially all of the operating assets of Metro-Tel. On December 1, 2009, the Company changed its name to EnviroStar, Inc.
Industry Overview:
The commercial and industrial laundry, dry cleaning equipment and boiler distribution business is highly fragmented with over 100 full-line or partial-line equipment distributors in the United States. Substantially all distributors are independently owned and primarily focused on local markets. In 2009, U.S. and Canadian sales in the commercial laundry equipment industry were made to the following customer segments: laundromats (43%), multi-housing laundries (30%) and on-premise laundries (motels, hotels, nursing homes, prisons, etc.) (27%). Commercial laundry equipment sales historically have been relatively insulated from business and economic cycles, given that economic conditions tend not to affect the frequency of use or replacement of laundry equipment. Continued growth will likely be sustained by population expansion and by customers increasingly trading up to equipment with enhanced functionality and therefore higher average selling prices.
Commercial dry cleaning industry in the United States consists of approximately 36,000 shops. Most of these shops are small businesses with fewer than 10 employees. This is a highly fragmented sector and is estimated to be an $8 billion annual opportunity.
Larger players in this industry include Whirlpool Corporation, The Dexter Company and Super Laundry Equipment Corp. and Alliance Laundry Systems. Also, Proctor and Gamble has entered into the commercial dry cleaning business. P&G launched its Tide Dry Cleaners franchise to leverage its marketing prowess as well as 60 years of experience in fabric care. Franchise costs include a $50k one-time franchise fee, an initial investment of $650-$1.0 MM, 7% royalty fee and 5% marketing fee. As a point of comparison, franchise fees for a Papa John's is a $5k one-time fee and a 5% royalty fee.
Given the size of EnviroStar as well as the privately-held nature of many of its direct competitors (specifically within the distribution business), public market comps and private market comps are not meaningful.
Accounting & Financials:
The accounting of the business is straightforward. Sales of products are generally recorded as they are shipped. Due to special options and features on most of the larger and more expensive equipment ordered by customers, in most instances, the Company purchases the equipment sold by it after its receipt of the orders from its customers. Commissions and development fees are recorded when earned, generally when the services are performed.
In 2003, the Company had total revenues of $14.5 MM and had $0.9 MM of operating income. During the LTM period ending FY 1Q'14, the Company had $38.2 MM of revenues and $3.0 MM of operating income. This represents a revenue and operating income CAGR of 10.4% and 12.8%, respectively. Lastly, earnings per share grew during this period from $0.09 to $0.27, representing a CAGR of 11.3%.
The company has a favorable outlook for FY 2014. Venerando Indelicato, Chief Financial Officer, stated: "As previously reported, we received a number of large orders for delivery in fiscal 2013, which we successfully delivered during the year. We are beginning fiscal 2014 with a solid backlog containing a few large orders, and while comparisons will be difficult when comparing fiscal 2014 with our recent banner year, we still expect fiscal 2014 to be a very successful year." Reported results for FY 1Q'14 was strong. Equipment sales, spare part sales and foreign sales increased by 40.7%, 14.6% and 70.4%, respectively versus FY 1Q'13. The Company only reports growth rates for these segments.
Disclosure: I am long EVI, .