Re-opening Play at a Discounted Price (with Sandbagged Guidance) $ABM

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Looking around, it’s hard to find discounted, pandemic-impacted stocks. The pandemic is approaching its final chapter, so the market is clearly bidding up names that will benefit from a boost in demand following the shocks of 2020 on some businesses (aviation, restaurants, and entertainment). But those sectors look “expensive” now, all things being equal. However, ABM is a stock that is undercovered and pretty interesting.

**This will be a different post than usual: I think the company is sandbagging guidance, so I spend a decent amount of time on that. However, I also like the business. It’s a service business, so there are some puts and takes (particularly operating leverage in the case that I am right), but they generate good FCF either way, have accretively deployed FCF historically, and have a clean balance sheet today. ABM is also a pretty underfollowed stock, which I like and think creates opportunity**

I should lay out my detailed thesis right up top:

  • ABM gained high margin, COVID cleaning work during the pandemic. The guidance basically implies that will fall off immediately post-Q1. But mgmt commentary on re-opening conditions plus contract terms imply this will likely last through the end of the year.
  • Aviation will come back and is still down by roughly half of what it was pre-pandemic.
  • Mgmt has sandbagged guidance; already ~35% of the way there with just Q1.
  • This is a decent business with good FCF that they historically reinvest back into acquisitions.

Quick Background

ABM started in 1909 as a window washing company (then known as American Building Maintenance Industries). Since then, they have grown into a large, diverse services company, mainly in the janitorial market.

Easiest way to think of them now is the service providers that clean commercial buildings, such as those that care for carpets in commercial buildings. They also handle parking management, landscape maintenance, and aviation services (like cleaning the aircraft, or those people you see assisting those in wheelchairs at the airport – that’s likely ABM).

They have 5 segments now, broken up by industries they serve: business & industry (52% of sales), technology & manufacturing (16%), Education (13%), aviation (11%) and Technical Solutions (8%).

So you can see, pretty diverse. But you can also see where I’m going: a decent chunk of the business was impacted by COVID.

As you look at each segment for FY2020, clearly Aviation was the most impacted followed by Technical Solutions (think of a services business to help control energy costs for a building – not really something you’d look to do in a cash preservation scenario).

However, the company also was able to grow EBITDA last year: This is because they pruned some low margin business heading into 2020 (good call) and cost control helped expand margins. Lastly, there were decent amount of COVID-related work that was high margin. More on that later in the post.

So again, here is where we get to the crux of my thesis:

  • The high margin work will continue through CY’21 and likely into CY’22.
  • Aviation will come back
  • Mgmt has sandbagged guidance; already ~35% of the way there with Q1.
  • This is a decent business with good FCF that they historically reinvest back into acquisitions for scale.

High margin work will continue through CY’21 and likely into CY’22.

Yes, we know the constant cleaning of everything for COVID was probably overkill. However, employees are still optically going to want to see heightened cleanliness as we all return to office. Its optics over reality, folks.

According to mgmt,

“average occupancy across the country is approximately 15%. We anticipate this could increase to 25% by Labor Day and grow to 50-plus percent through calendar year-end.”

Mgmt used their janitorial business as an opportunity in COVID. With “EnhancedClean”, they signed customers on to somewhat longer-term, very high margin contracts. Below they say work orders and EnhancedClean are similar margin (high) but they make the specific point that work order is 1x and EnhancedClean can be over the coming months.

The point is, when those employees officially head back post-labor day or by year end, they will want to see the office is a clean place. There will also need to be more cleanings done just as occupancy rises (another area where building owners could have cut costs in 2020).

Plus, with cost controls and pruning of the business, it seems to me like ABM’s margins should be somewhat higher anyway which they’ve talked about on the Q1 call.

Aviation will come back

I think aviation demand will come back, but maybe some business travel is gone forever. Fortunately, when it comes to sanitation, a flight can be 65% booked or 85% booked and the same amount of cleaning needs to be done.

Same for the actual airport. I think this segment comes back, though it is a pretty low margin business.

LTM, Aviation was $585MM in sales, down from $1,017MM in 2019. Seems like there is $400MM of incremental revenue opportunity. Assuming low margins at 3.5%, that’s $15MM of incremental EBITDA. It isn’t huge, but its upside to guide in my view. And I think it will come back quicker than most expect based on recent news.

Management is sandbagging

ABM released its FQ1’21 (ended Jan) on March 9th. Sales were down 7.5%, but EBITDA was +80% Y/Y with 400bps of margin expansion to 8.3%. Adj. EPS was $1.01 compared to $0.39 in the PY (which was pre-COVID).

For guidance, they’re calling for 6.6%-7.0% EBITDA margins and adj. EPS of $3.12 at midpoint.

I went back and looked historically: fiscal Q1 typically is around 25% of sales, but net income tends to be a bit less than a quarter. Q1 adj. EPS was already 32% of their guide ($1.01 of $3.12)

Hmmm…. It seems like management is calling for a strong reversal of current trends. Q1 also had 1 less working day! Aviation was also still very weak during holidays.

Let’s Do The Math

Sure, the high margin work probably will be going away in the long-run, but the rest of the business will be recovering. I think every one of their segments will likely grow sales this year. As stated, I also think the cleaning work will continue at least for this year (more on that below).

Here’s why I think they’ll beat that number:

  • Reasonable to assume sales will be down 5% or less this year
    • Q1’21 sales were down ~7% from Q1’19.
    • For full year sales to be down 5%, it implies the rest of the year will be down ~4%. I think that’s somewhat reasonable, though there’s upside based on Aviation.
  • Mid-point margin guide is 6.8% of sales, which points to $420MM of EBITDA ($6.174BN * 6.8%). HOWEVER, we know Q1 is $124MM of EBITDA at 8.3% margin, so that implies 6.3% margins for the rest of the year
    • This is too conservative – it basically means that high margin cleaning work will be drying up right after Q1!
    • This high margin work should persist because they’ve structured most of it as EnhancedClean under longer contracts

Another way of putting it: fast forward to Q2’21. Do you really think margins will fall by a lot? I don’t. I think Q2’21 will probably look similar to Q1’21. If that’s true, it implies 2H’21 will have super low margins. It doesn’t add up. Shown below, if you think Q2 is 8% margin, 2H will be 5.5% margin. Huh? No.

For the high margin work to evaporate, like their guide suggests, then this slide is false too:

Bottom line: under most scenarios I think the company will beat guide. To put $ amount to it, I think they’ll probably do >$3.45-3.50 in EPS, which is about an 11% beat. I think ABM stock will likely trade up higher than the beat, though. Either way, based on my experience, if ABM beats and raises guidance, the stock should outperform.

Decent Business with Good Reinvestment Potential

Ok I spent way too much time on their EBITDA guide, but I did so just to show confidence.

Let’s first break down FCF expectations. Not too shabby. Around an 8.4% FCF yield.

ABM also has $378MM of cash on hand whereas they typically keep ~$50MM or so. So they have $328MM of excess cash today (10% of market cap).

They’ll likely continue to paydown term loan and their revolver this year, so I think by year end, barring any acquisitions, they’ll have $500MM of excess on hand, or 15% of market cap and will be basically net debt zero.

ABM typically does bolt-on transactions, but the last deal they did was for GCA, a $1.25BN acquisition acquired for 12.5x. Let’s say they do another deal.

With $500MM of excess cash at 12.5x, they could acquire another $40MM of EBITDA (increases PF EBITDA by roughly 10%).

However, they could do another GCA-like deal, but debt-funded, and leverage would only go up to 2.4x. Not bad.

Net / net, I like ABM stock. It has good resiliency. The market is also fragmented, so I expect the acquisitions to continue. Lastly, it looks cheap. Really, the cherry on top is the low guidance which may serve as a catalyst for the stock to pop later this year.

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