ABM Industries: Near-Term Headwinds


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Investment Thesis

ABM Industries Incorporated’s (NYSE:ABM) revenue growth should face headwinds as slower-than-expected recovery of office occupancy should continue to result in lower work orders and there is a potential for real estate footprint reduction by corporates as well. In addition, the near-term challenges due to delayed project starts in its Technical Solutions segment should also adversely impact the revenue growth. Further, while the Education segment has benefitted from a shift from online to 100% in-class learning, I believe this trend has already played out and growth should slow in this segment as well. The company’s Aviation and Manufacturing & Distribution segments are seeing good growth thanks to the pent-up demand for leisure and business travel in the aerospace end market and the favorable reshoring trend in the manufacturing end market, but I don’t expect them to offset the near-term headwinds in

Revenue Analysis and Outlook

The company has seen good growth in the last few years helped by post-pandemic recovery as well as M&As. However, the growth has slowed to low single digits in the recent quarters due to slower than anticipated return to office trend which negatively impacted office occupancy. In the third quarter of 2023, the company’s Business & Industry (B&I) segment saw a 1.2% Y/Y revenue decline mainly due to reduced demand in the commercial office space market. However, this was offset by growth in other segments. The company’s Manufacturing & Distribution (M&D) segment’s revenue increased 6.6% Y/Y, the Education segment’s revenue grew 5.6% Y/Y, and the Aviation segment’s revenue increased 17% Y/Y. The Technical Solutions (ATS) segment’s revenue increased 6% Y/Y aided by 12% growth from the RavenVolt acquisition (completed in 2022), partially offset by a 6% decline in organic revenue. On a Consolidated basis, revenue growth of 3.4% Y/Y included a 2.5% increase in organic revenue and a 0.9% contribution from the RavenVolt acquisition.

ABM’s Historical Revenue Growth

ABM’s Historical Revenue Growth (Company Data, GS Analytics Research)

Looking forward, the company’s revenue outlook is mixed with its largest segment Business and Industry (B&I), which accounts for over half of its revenue and profits, expected to remain under pressure while trends in Manufacturing and Distribution, and Aviation are solid. The company’s Technical Solutions business is also facing some near-term headwinds but the longer-term prospects there are encouraging.

In the Business and Industry segment, the return to office trend hasn't been as strong as many corporates anticipated. So, the number of days per week employees spend in their office still remains low and it is impacting the volume of work orders for services dependent on office density.

However, I believe the worst is yet to come. As lower employee density continues, it is likely that corporates will start reducing their real-estate footprints, allowing some office leases to expire. This should have an even more significant impact on the company’s B&I segment as compared to lower work orders. So, I expect continued pressure in this segment in the near to medium term, and the segment’s revenue can see another leg down.

On the other hand, the company is seeing good strength in its Manufacturing and Distribution segment. With the recent trend towards reshoring of manufacturing facilities catalyzed by the Federal Stimulus from CHIPS and Science Act and Inflation Reduction Act, the manufacturing end market is expected to see continued strength in the near as well as long term. The company is focused on diversification in this business and expanding its business with clients in the manufacturing, semiconductor, and biopharma industries which should help growth.

Another segment seeing a good strength is Aviation and it is not difficult to see why. There has been a good pent-up demand for leisure as well as business travel after reopening which is helping ABM. The company also continues to win new business and cross-sell additional product lines to existing clients which should continue to drive growth in this business.

The company’s education segment is also seeing good growth driven by a shift from online to in-class learning. This segment has seen mid-single-digit growth in the last few quarters. However, as we have already returned to almost 100% in-class learning, I believe the growth should normalize in the coming quarters as comparisons get tough.

Finally, while the company has a good medium to long-term opportunity in its Technical Solutions (ATS) segment as the global demand for EV charging infrastructure and microgrids, particularly battery storage systems remain strong, there are some near-term headwinds. The company is seeing some delays related to local permitting and utility issues that are impacting the deployment of large-scale battery storage systems. These systems are relatively new and local governments are not accustomed to dealing with the requirements of these projects resulting in delayed permits. Additionally, in Q3FY23, the company also saw a delay in the rollout of EV charging infrastructure at one of its large automotive dealer clients which was earlier expected to accelerate rollout in the second half of FY23. While these factors are a headwind, I believe they are only transient in nature and the medium to long-term prospects of the company’s Technology Solutions business remain good.

Overall if we look at the company, I believe the decline in the B&I segment should worsen in the coming quarters. This coupled with near-term headwinds in the Technology Solutions business as well as slowing growth in the Education business (which has already benefited from 100% in-class learning) should more than offset continued strength in Aviation and Manufacturing and Distribution businesses. The company has seen low single-digit growth in the first 9 months of FY23. I believe its growth can turn negative in the coming quarters.

Margin Analysis and Outlook

In Q3 FY2023, the company’s margins were adversely impacted by inefficiencies related to project delays, lower volumes in B&I, and a decrease in higher-margin work orders. Cost-saving initiatives partially offset these factors. This resulted in a 60 bps and a 20 bps Y/Y decline in gross margin and adjusted EBITDA margin, respectively. Segment Wise, the operating margin of B&I declined 30 bps Y/Y, M&D declined 60 bps Y/Y and ATS declined 290 bps Y/Y. On the other hand, the Education and Aviation segments operating margin expanded by 30 bps Y/Y and 20 bps Y/Y, respectively.

ABM’s Segment Wise Operating margin

ABM’s Segment Wise Operating margin (Company Data, GS Analytics Research)

ABM’s Gross margin and Adjusted EBITDA margin

ABM’s Gross margin and Adjusted EBITDA margin (Company Data, GS Analytics Research)

The company is taking a lot of steps under its “ELEVATE initiative” to drive workforce productivity and reduce costs. Some initiatives include the deployment of a cloud-based ERP system across ABM and leveraging the company’s workforce productivity and optimization tools which provides advanced analytics into productivity levels across various teams. According to management, the use of the productivity tool resulted in a 10% improvement in gross margin on the jobs where the tool was piloted. As these solutions get deployed across ABM, they should help margins in the long run.

However, I don’t think they should be able to offset the near-term headwinds from volume deleverage especially in the B&I segment. At the time management introduced its ELEVATE initiatives in late 2021, they had a ~7% adjusted EBITDA margin goal for FY25. However, a lot of things have changed since then and the slowdown in the office end-market has come as a big negative surprise given ABM’s exposure to this market. So, I don’t see the company achieving this target by FY2025. I am expecting flattish margins in the near to medium term as the company’s productivity initiatives get offset by volume deleverage.

Valuation and Conclusion

ABM is currently trading at 12.04x FY24 consensus EPS estimates and 12.45x FY25 consensus EPS estimates, which is at a discount versus the company’s average forward P/E of 15.19x over the last 5 years.

While the valuation is lower than historical, I don't like the company’s near-term revenue outlook with headwinds arising from continued weakness in the B&I segment, near-term challenges in the Technical Solutions segment, and slowing growth in the Education segment offsetting the growth in the Aviation and Manufacturing and Distribution segment. The margin outlook is also mixed with volume deleveraging, particularly in the B&I segment offsetting the benefits from the company’s productivity initiatives. So, considering the near-term revenue and margin challenges, I have a neutral rating despite low valuations.