ABM reported a fine Q3’21 – EBITDA increased 20% on a 14% increase in sales and was slightly ahead of expectations. However, the stock is down about 10% since reporting and was down >15% at one point.
Must be a terrible outlook, right?
Well, their EPS guide at midpoint was around consensus BUT only if you exclude costs related to their ELEVATE investment program. Otherwise EPS would be $2.67 at mid-point vs. $3.43.
ELEVATE expenses will be $72MM next year and between $150-$175MM over the next 4 years. About half of the ELEVATE spend will be digital transformation costs, 20% for growth and the rest for workforce and people capabilities.
But that investment seems well worth it.
In return, the company expects margins to exceed 7% (from 4% back in 2017 and 5% in 2019. High margin COVID clean-up work led margins to be 6-7% in 2020-21 which no one believes is sustainable).
So think better price optimization, better sales targeting across business lines, better software. Also more capable / productive labor management, which will be needed in a tight labor market.
In addition, mgmt expects to acquire another $900MM in revenue (total of $2BN including the recent Able acquisition). That means 2025 revenue will exceed $9BN and EBITDA should exceed $630MM (from $375MM at end of 2020).
All in all, I’m a long-term investor and the company is investing for the long-term. I get the disappointment – maybe on some level this is an admission that the company has some real expenses to be competitive. At the same time, it’s not like expenses have to go up for revenue and EBITDA to be flat (that’s a real issue).
In my prior posts, I’ve noted how ABM is a compounder no one really talks about – they take cash flow from the main business and expand into others or grow their core. The company has solid exposure to warehousing, which will clearly be growing rapidly over the next 5 years with Amazon and Shopify.
As an aside, they discussed getting into more technical positions. Frankly, I know one business called Therma which does HVAC services, but for high-tech areas like labs and semiconductor fabs where HVAC truly is mission critical and limited providers can do it. I’d leap if they got this thing (currently owned by PE). Not really in their current wheelhouse, but not too far of a stretch either.
At the same time, ABM continues to look very cheap.
This update will be brief, but I wanted to highlight that ABM recently reported last week, following its M&A announcement that I covered in this note.
When I first wrote about ABM stock, I said (i) guidance was way too low, and I expect a lift in guidance across the board (ii) there’s upside optionality from doing a large acquisition and (iii) the stock is cheap.
If you had told me that ABM would go on to raise EPS guidance TWICE and announce an $830MM accretive-day-one deal, yet ABM stock would be little changed, I’d be SHOCKED. The stock is actually down about 6% since I wrote about it…
When ABM reported, they increased EPS guide now to $3.5 at mid-point. This is now at the high range of the previously stated EPS guide.
Not to brag, but this is exactly where I thought it should be, which you can see in the original table I posted:
Why the Muted Reaction?
I struggle to believe this was “priced in” to ABM stock when I first wrote about it, I just think sustainability of earnings is being questioned. However, management actually noted the current high margin environment will likely persist for even longer than I thought:
Overall, demand for ABM’s higher-margin virus protection services remained elevated in the quarter, underscoring ongoing client concerns regarding cleaning and disinfection of their facilities. As anticipated, demand for virus protection eased slightly in the third quarter compared to the second quarter of fiscal 2021, but remained well above pre-pandemic levels. The emergence of the Delta variant and rising COVID-19 cases nationally have gained heightened interest in the need for disinfection prevention measures, particularly in high-traffic areas. As we look forward to 2022 and beyond, we believe that virus protection services will remain a contributor to our overall revenue as disinfection becomes a standard service protocol in facility maintenance programs
….So I think it’s still hard for us to pin down a formal long-term margin. We’re looking forward to giving you full year guidance in the next 3 months, and then that will give you the insight for the next year. But look, we’re going to say what we’ve continued to say throughout, which is the 2 areas for elevated margins are in disinfecting and labor arbitrage. And we believe we will permanently keep portions of that. As we restaff these buildings, we believe we’re going to be able to do it more efficiently, and we’ll capture some savings. Again, it’s still too early to figure out how much.
And then the disinfecting, we see like maybe 2 quarters ago, there was — or maybe even a quarter ago, there was no Delta variant, right? So like I think this is going to continue to evolve. And we’ve all just said it even anecdotally. It’s just… I don’t think facility managers or landlords or principals of schools, I don’t think anyone thinks it’s responsible to discontinue disinfection services, especially in high-touch areas. So that’s going to continue, too. So we believe we will continue to be elevated, but give us until next quarter when we do full year guidance to kind of give you that year outlook.
So again, I go back to the original pitch. I’m not necessarily expecting this work to last forever, but here’s what ABM will do (and basically already did):
they’ll generate a ton of FCF (about 11% of market cap by my math)
they will use cash first to pay down debt from the Able acquisition
Once they are in a comfortable range, they’ll buy something else
Rinse & Repeat
This is what compounders do, it’s just a bit frustrating when this compounder gets no love.
I think the pushback is that margins likely will go down in the future – but what does it matter if earnings DOLLARS are higher? (They buy something else, there are some structural changes in the business, aviation and education segments are roaring back at higher margins which is happening, etc.)
The point of this slide to me is not that ABM is some dividend stock, but that it does a pretty good job compounding earnings.
In my prior ABM post on June 2nd, I made the call the ABM was sandbagging guidance and they would likely beat and raise. Part of that thesis was (i) the company’s sales were still down, but likely going to improve significantly and (ii) its margins would be much higher than they forecasted and (iii) since we already had Q1, it gave us lots of clues for the rest of the year.
Lo and Behold:
Got pretty close. Time will tell for the full year if they come in at high end of guide like I suspected in my article:$ABMpic.twitter.com/2EDzmIubRo
Enhanced Clean, our proprietary and trusted protocol for cleaning and disinfecting spaces was an important contributor to our second quarter results as well.
…our clients in both the office and manufacturing markets indicate they plan to continue to incorporate disinfection into their cleaning protocols as they prepare for the return of staff and workers to their offices and industrial facilities. In fact, given the heightened concerns around pandemic risk and greater awareness of public health issues in general, we expect these specialized services to remain in demand and to become part of our client contracts.
….school districts have accelerated the return to in-person learning. Our conversations with school district professionals and educational institutions indicate that with the full-time return to school expected this fall, cleaning and disinfecting will be a priority throughout the school year
Recall, this is high margin work for ABM. I don’t think it will last forever, but like my previous posts on Dollar General and Big Lots, ABM has more cash than ever. Typically they redeploy that cash in acquisitions. So we now have a free option. Oh yeah, they also straight up alluded to that in the call:
Additionally, we continue to explore acquisition opportunities where as a strategic buyer, we would be able to drive meaningful revenue and operating synergies.
Last thing I’ll say on the margin front is to call out their Technical Solutions segment. This is their highest margin segment and guess what?
And then the last thing, and you mentioned it is, technical solutions, we have a backlog of over $250 million in business, our strongest ever.
…And so we’re excited about that to actually turn the work.
So I think you’re going to see revenues go up in the second half. You’re going to see disinfection strong. You’ll see, again, the mitigation on the labor side, but you’re also going to see ATFs sure enough as well. So I think we feel really good about that. And we’ll see where it goes into ’22 as we get closer to that. And again, November 1 starts our ’22. And I think that’s still going to be at the time where people are returning to work. And so I think we’ll have a good start to ’22 as well
Sounds to me like everything is going well.
Bottom line: I think there’s even more upside to the EPS guide, frankly. There are some puts and takes, but I continue to like the outlook.
Again, a lot of my commentary was on mgmt sandbagging, but at $50, we have a ~10% FCF yield stock, ex cash, for something that isn’t overly levered and a relatively good business.
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.
