EMCOR: Accretive Growth Spurred By Diversified Positioning, Macro Tailwinds (EME)

EMCOR (NYSE:EME) is a Norwalk, Connecticut-based mechanical and electrical construction, industrial and energy infrastructure, and building services company. The firm is comprised of >80 operating companies, with over 180 locations, employing >35,000 workers.

Through its activities, EMCOR has achieved Q2 revenues of $3.05bn- a 12.49% YoY increase- alongside a net income of $140.59mn- a 39.67% increase- and a free cash flow of $286.11mn- a 371.21% increase driven chiefly by rising operating income but also by growth in investing and financing cash flows.

Introduction

Central to EMCOR’s success remains the twofold prospects of a diverse revenue base alongside a highly specialized one. In addition to providing resilience measures, this two-pronged strategy enables superior margin expansion and scalability, with niche services complimenting one another and cross-selling much more likely.

Moreover, EMCOR is able to respond to a range of macro trends; higher oil prices, for instance, would support the expansion of EMCOR’s Industrial Services segment, while greater investment in renewables could support Construction Services revenues, principally through electrical construction.

This business model, alongside general macro tailwinds, and the firm’s moderate undervaluation lead me to rate EMCOR a ‘buy’.

Valuation & Financials

General Overview

In the TTM period, EMCOR’s stock- up 87.25%- has experienced superior price action to both TradingView’s construction index- up 41.88%- and the broader market, as represented by the S&P 500 (SPY)- up 6.17%.

I believe the construction industry’s outperformance is a product of increased private and public investment, between the Inflation Reduction Act, Infrastructure Investment and Jobs Act, and the rise of infrastructure funds in asset management and private equity.

EMCOR in particular is well-positioned to take advantage of these opportunities, with specialized operations in construction/building services well-equipped for increased general infrastructure investment- roads, bridges, etc.- and renewables. This proposition is further enhanced by EMCOR’s semiconductor construction capabilities, buoyed by the CHIPS Act.

Comparable Companies

The construction industry remains highly fragmented, with a range of niches and products, regional specialties, regulatory frameworks, and so on. As such, rather than compare EMCOR directly to competitors, I sought to compare the form to similarly sized construction and engineering firms. This group includes AECOM (ACM), a Dallas, Texas-based multinational infrastructure consultant, Mobile Mini owner, WillScot (WSC), Edmonton, Alberta-based designer and consultant, Stantec (STN), and Florida-based utility and communications infrastructure firm, MasTec (MTZ).

As demonstrated above, EMCOR has experienced best-in-class YoY and QoQ price action, likely a product of the firm’s outsized presence in rapidly growing construction sectors, such as semiconductors and renewables.

Despite this, EMCOR remains a value proposition on a multiples basis, when considering growth, and assessing balance sheet strength.

For instance, EMCOR retains the lowest trailing and forward P/E multiples, which, in conjunction with the lowest debt/equity ratio and highest book value per share, exemplify multi-sided value across all financial statements.

Moreover, not only does EMCOR sustain superior reinvestment capability, but is able to capture more growth with said investment; the construction company supported best-in-class ROE, ROA, and second-best revenue growth in the peer group.

Valuation

According to my discounted cash flow valuation, at its base case, the net present value of EMCOR is $280.22, meaning, at its current price of $221.37, the stock is undervalued by ~21%.

My model, calculated over 5 years without built-in perpetual growth, assumes a discount rate of 9%, incorporating the firm’s debt-light cap structure and its higher equity risk. To remain conservative, I projected an average forward 5Y revenue growth rate of 7%, lower than the 5Y trailing average of 7.78%, addressing potential recessionary risks in spite of general macro tailwinds.

On the contrary, Alpha Spread’s multiples-based relative valuation estimates that EMCOR is overvalued by 16%, with a fair value of $184.76. This overvaluation approximation is likely due to the firm’s growth positioning relative to more stagnant or slow-growing construction peers, leading to higher multiple pricing.

Therefore, using an average of my NPV and Alpha Spread’s relative valuation, the fair value of EMCOR is $232.49, meaning the stock is undervalued by ~2.5%.

EMCOR’s Leadership in Specialized Construction Sees Expansion From Long-Run Demand Expansion

As extensively discussed, at the core of EMCOR’s growth proposition remains its diverse presence, able to effectively position itself to leverage macro growth. Case in point, data centers and semiconductor fabs are seeing exponential growth in public and private investment in the US, with EMCOR positioned to profit. Similarly, but in a completely different capacity, there has been a greater recent focus on indoor air quality maintenance, with wildfires and the COVID-19 pandemic emphasizing air quality- EMCOR is positioned to capture revenues from there as well.

Beyond the resilience and growth opportunity diversification lends, best expressed by the below image demonstrating forward revenue diversity, EMCOR’s decentralized nature enables upselling and cross-selling opportunities. Moreover, since most business occurs through subsidiary firms, EMCOR endures less legal liability and is more specialized on a regulatory and operational level.

Wall Street Consensus

Analysts generally support my positive view of EMCOR, projecting an average 1Y price target of $237.50, an 8.01% increase.

Even at the minimum forecasted price target of $225.00, investors see superior risk-adjusted returns, with investor anxieties largely a reflection of macro uncertainty surrounding interest rates and the like rather than EMCOR’s operational risk.

Risks & Challenges

Rising Interest Rates Increase Costs, Depress Short-Run Demand

Although EMCOR maintains the lowest relative debt/equity ratio among peers, as demonstrated in the ‘Comparable Companies’ section, the firm is nonetheless exposed to downstream demand pressures. Rising interest rates reduce investment in capital-intensive projects, such as construction and infrastructure, thus reducing the scalability of the company and the growth of free cash flows.

Regulatory Compliance Costs May Increase With Subsidies

Asides from general localized regulatory complexities- which EMCOR navigates well due to its 80+ subsidiary firms, each specialized in different geographies and verticals- increased federal subsidies will inevitably lead to wider scrutiny. As such, EMCOR may face excess compliance costs which may reduce profitability and the ability for the firm to expand.

High Degree of Fragmentation Increases Price and Talent Retention Pressure

The construction industry remains highly fragmented between a variable set of niches and geographies. As such, EMCOR faces multi-sided competitive intensity from smaller, local firms in addition to multinational infrastructure consulting firms and the like. This may lead to price competition or talent retention competition, increasing human capital costs as well as reducing fee-charging capabilities.

Conclusion

EMCOR remains a highly diversified firm with a broad revenue base, well-positioned leverage macro tailwinds and return value to investors for years to come.