EVI Industries’ Buy-And-Build Strategy Could Push The Price Up

With many years in the distribution of washing equipment business, EVI Industries, Inc. (NYSE:EVI) runs a buy-and-build strategy, which may accelerate free cash flow growth. In my view, the current financial position would most likely allow more aggressive M&A operations to sustain revenue growth. Besides, more agreements with a large number of suppliers could help deliver more FCF margins. The increases in the transportation costs or labor costs represent risks for EVI, however the company remains undervalued.

Significant Number Of Customers And Expertise In Buying Competitors

With a presence in the industry since 1959, EVI Industries is one of the leaders in terms of the distribution of washing equipment, industrial boilers, different parts of these devices, supply services, and technical advice.

EVI currently has more than 60,000 active clients, located mainly in the United States, Canada, the Caribbean, Latin America, and other parts of the world. These clients range from laundries for retail use to industrial laundries as well as services for corporations, government entities, hospitals, medical care rooms, veterinarians, professional sports establishments, educational entities, cruise ships, and hotel establishments. I believe that the diversification of the customer base will likely bring the attention of investors. If EVI loses a few clients, it may not matter as there are many other clients working with the company. None of its clients represented more than 10% of its income in the years 2021 and 2022.

Another point that stands out is the experience and recognition of Henry Nahmad, current president and CEO of the company. Nahmad served at similar positions in large, capital-moving companies such as Watsco Inc. (WSO), the world’s largest distributor of air conditioner-related products. Although the type of products is far from those that EVI sells, it is not only a matter of track record in managing large teams and million-dollar operations, but, above all, the similarity in the acquisition strategy that positions Henry Nahmad as the person indicated in this post.

In a highly competitive market, in which there are some 500 lines of equipment distributors in the United States, EVI stands out mainly for being the company in this area with the largest market share. In the United States, it relies on its distributors and subsidiaries to compete primarily with other independent distributors. At a global level, the competition is accentuated in the regional distributors, although EVI stands out thanks to the efficiency of its services as well as the experience in the planning and execution of its business plans.

The Asset/Liability Ratio Stands At Close To 2x

As of September 30, 2022, the company reported cash worth $3.774 million, together with accounts receivable of $44.320 million and inventories worth $54.244 million. Contract assets stood at $5.3 million with other current assets of $5.943 million. In sum, total current assets stand at $115.478 million, much more than 1x the total amount of current liabilities. I don’t see liquidity issues on this name.

With regards to the company’s non-current assets, equipment and improvements stood at $12.941 million. Besides, EVI reported operating lease assets of $7.151 million, intangible assets of $25.708 million, and goodwill of $71.714 million. Finally, total assets stand at $241.046 million.

EVI’s liabilities include accounts payable worth $42.213 million together with accrued employee expenses of $9.379 million. Besides, customer deposits were $19.696 million, and the current portion of operating lease liabilities was $2.471 million. Finally, total current liabilities were equal to $73.759 million.

Non-current liabilities disclosed included deferred tax liabilities worth $4.798 million with long term operating lease liabilities of $5.440 million. Besides, long term debt stands at $35.843 million, and total liabilities were equal to $119.840 million. The asset/liability ratio stands at close to 2x, so I believe that EVI reports a solid financial position.

Case 1: Successful Buy-And-Build Strategy And Better Equipment

EVI operates a buy-and-build strategy, which translates into permanent attention on the possibilities of acquiring companies in the same industry to integrate into their business segments. In this way, EVI maintains its own brands and the brands of the purchased companies as well as the previous operation of these companies. It supports the long-term business relationships and contracts of the acquired companies. This not only expands IVE’s operations and growth, but also offers advantages over its smaller competitors. Recent acquisitions clearly indicate that EVI is very active in the mergers and acquisitions market.

On September 1, 2022, the Company acquired Aldrich Clean-Tech Equipment Corp., a Massachusetts-based distributor of commercial, industrial, and vended laundry products, and K&B Laundry Service, LLC , a North Carolina-based distributor of commercial, industrial, and vended laundry products. Source: 10-Q

Considering EVI’s current financial position and lack of debt, I believe that we could expect significant inorganic growth in the coming years. As a result, economies of scale may bring FCF margin expansion.

I am also quite optimistic about EVI’s intentions to acquire better equipment, which will likely lead to a larger number of customers and perhaps higher margin products. Management made a commentary about this strategy in the most recent quarterly report.

The Company believes that a greater installed base of equipment strengthens the Company’s existing customer relationships and may lead to increases in the total number of customers, consequently creating a larger and stronger customer base to which the Company may sell products and services. These may include certain higher margin products and services and any additional products and services which the Company may offer or sell from time to time as a result of any business acquisitions, the sale or lease of complementary products, and expansion of its service operations. Source: 10-Q

Under the previous conditions, I forecasted 2027 revenue of $359.56 million, 2027 EBITDA of $16.45 million, and an approximate EBIT of $10.94 million. If we also assume an effective tax rate 31.44%, the 2027 EBIAT would be $7.5 million. Besides, I included depreciation of around $5.51 million, changes in accounts receivable of -$2.83 million, change in inventories of -$2.52 million, and changes in accounts payable of $1.61 million. Finally, with capital expenditure of -$4.28 million, the unlevered FCF would be $5 million.

With a WACC of 7.80%, the net present value of future FCF would be $32.66 million. I believe that my figures are quite conservative.

If we assume a perpetual growth rate of 5% and a WACC close to 7.8%, the implied FCF would be $5.25 million. I also forecast a terminal value of $187.57 million accompanied by a present value of the terminal value of around $128.85 million.

In sum, I obtained an enterprise value of $161.51 million, which, with cash of $3.7 million and debt of $35.8 million, implied an equity valuation of $129.41 million and a fair price of $10.34 million.

Case 2: Internationalization In Latin America, Many More Agreements With Suppliers, And More Aggressive M&A Operations

Under my best case scenario, I assumed that EVI will successfully work with many more manufacturers and suppliers. As a result, management may be able to renegotiate supply agreements, and EVI will acquire equipment at lower costs. In this scenario, I assumed that the company’s free cash flow would trend north.

Under this scenario, I also assumed that EVI’s international efforts will be even more successful than those in the past. If the company hires more sales personnel in Latin America, and uses its know-how accumulated in the United States, I am optimistic about the business outcome. In my view, considering the company’s balance sheet, if EVI requires debt to launch international operations, bankers will likely offer financing.

Finally, I also assumed that EVI, in this case, will acquire significantly more businesses than in the past. In my view, the CEO has sufficient expertise acquired in Watsco to accelerate the acquisition of competitors. Let’s also keep in mind that EVI could use more leverage in order to accelerate inorganic growth.

Under the previous conditions, I forecasted 2027 net revenue of $537.67 million, 2027 EBITDA of $83.55 million, and 2027 EBIT of $75.5 million. If we also include an effective tax rate of 31.55%, 2027 EBIAT would be close to $51.55 million.

I also assumed 2027 depreciation close to $8.25 million, changes in accounts receivable of -$9.5 million, changes in inventories of around -$8.5 million, and changes in accounts payable of $5.45 million. With capital expenditure of -$6.39 million, I obtained unlevered FCF of $40.95 million. If we also assume a WACC of 7.8%, the net present value would be around $135 million.

If we use 2028 free cash flow close to $42.5 million, and use a perpetuity growth method, the terminal value would be $1.295 billion. In sum, I obtained a net present value of terminal value of $890 million.

My results would include an enterprise value of $1026.55 million, equity close to $995 million, and a fair price of $79.5 per share.

Risks: Transportation Costs, M&A Failure, And Labor Costs Increases

Although EVI’s positioning naturally offers a number of advantages and benefits regarding its position in the market and with clients, it actively operates with risks both nationally and internationally.

The distribution lines depend on a large number of companies managed by third parties. Besides, international trade is undergoing a pronounced crisis in terms of transportation costs. A cut in distribution lines, which could reduce its position with respect to regional competitors, as well as an increase in transportation costs, which is translated into the price of its services, could negatively affect the company’s operations. As a result, the company’s revenue may be lower than expected, and the FCF margin could also decline.

I also consider a risk for EVI that future acquisitions don’t deliver expected synergies, or the revenue is lower than expected. Besides, the merger integration could fail, which could erase some of the value expected by management. Management clearly disclosed these risks in the last quarterly report.

As a result of these or other problems and risks, acquired businesses may not produce the revenues, earnings, cash flows or business synergies anticipated, and the acquired businesses may not perform as expected. As a result, the Company may incur higher costs and realize lower revenues and earnings than anticipated. The Company may not be able to successfully address these problems, integrate any acquired businesses or generate sufficient revenue to offset the associated costs or other negative effects on its business. Source: 10-k

Finally, I believe that labor market disruptions and increases in the labor costs significantly damage the company’s FCF margins, and may lower EVI’s fair valuation. Considering the current level of inflation, I believe that an increase in labor costs could occur:

If labor market disruptions and/or labor cost increases continue, the Company’s sales or service team could be short staffed and would be more costly to retain, and the Company’s ability to meet its customers’ demands or expectations could be adversely impacted, any of which could materially adversely affect the Company’s business and results of operations. Source: 10-k

My Takeaway

EVI Industries’ buy-and-build strategy and the expertise of the CEO in Watsco appear sufficient to expect successful M&A operations. I also believe that EVI’s balance sheet is in a good position to acquire many more targets, which would most likely lead to even more free cash flow growth. In my view, working with more suppliers could help the company renegotiate supply contracts, and enhance future EBITDA margins. Even taking into account risks from transportation costs or increases in labor costs, in my view, the upside potential in the stock price is significant.