Almost two years ago, I recommended buying ABM Industries (NYSE:ABM) for its reliable growth trajectory and its cheap valuation. Since my article, the stock has remained flat, having traded within a tight range. Such a trading pattern usually exhausts investors, leading them to sell their shares and look elsewhere for attractive returns. However, it is important to note that ABM Industries has matched the performance of the S&P 500 during this period. In other words, the shareholders have not experienced worse performance than the broad market. In addition, the Dividend King remains cheaply valued. Therefore, investors should purchase the stock and wait patiently for the growth thesis to play out.
Business overview
ABM Industries has a history of more than a century and engages in the provision of integrated facility, infrastructure, and mobility solutions in the U.S. and in international markets. Its offerings include energy solutions, electrical, janitorial, mechanical and parking. The company has a wide range of customers, such as hospitals, universities, schools and airports.
ABM Industries is a leader in a low-margin industry. To be sure, its operating margin has remained 3%-6% over the last five years. Thin margins are unappealing on the surface but they offer ABM Industries a strong competitive advantage; small competitors cannot match the economies of scale of the leader in this industry and hence they can hardly compete with ABM Industries.
As ABM Industries has a relatively boring business model, it passes under the radar of most investors. This is a shame, as the company has an impressive performance record. It has grown its earnings per share every single year over the last 20 years. This outstanding consistency is a testament to the dominant position of ABM Industries in its industry and its reliable growth strategy. Moreover, the facility services provider has grown its earnings per share by 10.3% per year on average over the last nine years. This is undoubtedly an attractive growth rate for an established business.
ABM Industries pursues growth by expanding its business with its existent customers but also by acquiring smaller companies and achieving great synergies from these acquisitions. A great example is the acquisition of Able Services for $830 million in cash in 2021. Able Services, which provides building maintenance, engineering and facility operations in the U.S., generates annual revenues of $1.1 billion and EBITDA of $65 million. ABM Industries has stated that it expects $30-$40 million of synergies from this acquisition. As the deal value is 28% of the current market capitalization of ABM Industries, it is evident that this acquisition will probably be a material growth driver in the upcoming years.
It is also remarkable that ABM Industries has enjoyed impressive business momentum over the last three years. While the fierce recession caused by the pandemic in 2020 took its toll on the results of many companies, ABM Industries grew its earnings per share 19% in that year, from $2.05 to an all-time high of $2.43, thanks to a steep increase in the demand for facility services in that year. Even better, the company grew its earnings per share by another 51%, from $2.43 in 2020 to $3.66 in 2022.
ABM Industries has somewhat decelerated this year but it still exhibits decent business performance, especially given the tough comparisons the company is facing due to blowout earnings in the last two years. In the most recent quarter, ABM Industries grew its revenue by 5% over the prior year’s quarter and its adjusted earnings per share by 1%, from $0.89 to $0.90, thus exceeding the analysts’ consensus by $0.04.
Management also reaffirmed in June its guidance for annual earnings per share of $3.40-$3.60. At the mid-point, this guidance implies a 4% decrease over the prior year, the first annual decrease since 2003. However, given the blowout earnings in each of the last three years, it is only natural that the growth trend may pause for a year, especially given the headwinds from high cost inflation and a slowing economy.
On the bright side, analysts seem to agree that ABM Industries will return to growth mode next year thanks to its aforementioned acquisition of Able Services and a potential expansion of its business with existing customers. Analysts expect ABM Industries to grow its earnings per share by 10% next year and by another 7% in 2025, to a new all-time high of $4.13. Notably, the company has exceeded the analysts’ estimates in 19 of the last 20 quarters. Therefore, it is likely to meet or exceed the expected earnings per share of $4.13 in 2025.
Valuation
ABM Industries is currently trading at a price-to-earnings ratio of 12.9, which is much lower than the 10-year average price-to-earnings ratio of 16.8 of the stock. It is also worth noting that the stock is trading at only 11.0 times its expected earnings in 2025. The exceptionally low price-to-earnings ratio of the stock has resulted primarily from the surge of interest rates to multi-year highs this year. High interest rates significantly reduce the present value of future earnings and thus they tend to compress price-to-earnings ratios.
However, thanks to its aggressive policy, the Fed has already driven inflation from a 40-year high of 9.1% last summer to 3.0% now. Whenever inflation reverts to the target range of 2.0%-2.5% of the Fed, the central bank is likely to begin lowering interest rates from the current multi-year highs. When interest rates moderate, the stock of ABM Industries is likely to enjoy an expansion of its price-to-earnings ratio towards its historical average of 16.8. In other words, the stock could enjoy up to 53% upside (=16.8/11 – 1) over the next two years if interest rates fall significantly off their current levels.
Dividend
ABM Industries has one of the longest dividend growth streaks in the investing universe. It has raised its dividend for 55 consecutive years and hence it is a Dividend King. It also has a payout ratio of only 24% and hence it can easily continue raising its dividend for many more years, especially given its reliable growth trajectory.
Unfortunately, there are two caveats in reference to the dividend. First of all, the stock is offering a dividend yield of 1.9%, which is lackluster for income-oriented investors, particularly given the environment of high interest rates prevailing right now. Moreover, ABM Industries has grown its dividend by only 3.7% per year on average over the last decade. Therefore, its dividend growth rate is hardly sufficient to make up for the modest current dividend yield.
Risk
While the dividend yield of ABM Industries is uninspiring, the stock is attractive for its reliable growth and its cheap valuation. As mentioned above, whenever interest rates revert to normal levels, the stock is likely to enjoy a meaningful expansion of its price-to-earnings ratio. It is also important to note that ABM Industries has proved resilient to recessions, such as the Great Recession and the coronavirus crisis. Therefore, a potential recession is not a major risk factor for this defensive stock, in contrast to most stocks.
On the other hand, the primary risk factor is a scenario of persistently high inflation and interest rates for years. In such a case, the valuation of the stock may remain compressed for a considerable period. However, such an adverse scenario has low odds of materializing due to the determination of the Fed, which is doing its best to restore inflation to 2.0%-2.5%.
Final thoughts
ABM Industries has a mundane business model and thus it passes under the radar of most investors. In addition, the stock has remained essentially flat over the last two years, in line with the performance of the S&P 500. However, its solid performance record and its cheap valuation render the stock appealing for patient investors. Investors with a long-term perspective are likely to enjoy a double gift in the long run; greater earnings and a higher price-to-earnings ratio.
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