It's the time of year to reflect and pick out some investment ideas for 2021. My choice in the industrial sector is Carrier (CARR 2.09%). The stock had a remarkable year in 2020, rising by a whopping 214% after it began trading as an independent company in early April, but I think there's more to come in 2021. Here's why.
Up 214% in 2020 but still a good value
Just because a stock has gone up a lot it doesn't mean it isn't a good value. Indeed, Carrier still looks like a good value on a relative and absolute basis. For example, here's Carrier compared to its heating, ventilation, air conditioning, and refrigeration (HVACR) peer group.
Image source: Getty Images.
In terms of both price-to-free cash flow (FCF) and enterprise value (market cap plus net debt)-to-earnings before interest, taxation, depreciation, and amortization (EBITDA), Carrier remains the cheapest stock in its peer group. For reference, its closest peer among the group is Trane Technologies (TT 0.25%).
Data by YCharts
Carrier's plan for 2022
To understand the industrial company's absolute valuation you have to appreciate the changes its made since the company was separated from the former United Technologies. One of the key initiatives is its so-called "Carrier 700 program." The plan is to cut Carrier's annual costs by $700 million by 2022. The cost savings will come from a combination of supply chain procurement improvements (shifting from high cost to low cost supplies), reducing factory costs by increasing the use of automation, and lowering general and administrative costs by sharing services.
The program is obviously progressing well because it started out as a $600 million plan, only to be increased to $700 million in the third-quarter earnings call.
The cost saving improvements will finish in 2022 and contribute to the company's EBITDA and FCF margin expansion in that time. As such, Wall Street analysts expect Carrier to generate $1.75 billion in FCF in 2022. Based on the current market cap of $32.1 billon, that would put Carrier on a price-to-FCF multiple of 18.3 times. Again, this compares favorably with Trane's expected price-to-FCF multiple of 24 times. Whichever way you look at it, Carrier is a good value.
| Metric |
2020 Est. |
2021 Est. |
2022 Est. |
|---|---|---|---|
|
Net sales |
$17.31 billion |
$18.27 billion |
$19.27 billion |
|
EBITDA |
$2.58 billion |
$2.9 billion |
$3.24 billion |
|
EBITDA margin |
14.9% |
15.9% |
16.8% |
|
Free cash flow |
$1.53 billion |
$1.53 billion |
$1.75 billion |
|
Free cash flow margin |
8.8% |
8.4% |
9.1% |
Data source: marketscreener.com, author's analysis.
Near-term growth prospects
Carrier has very good momentum going into 2021. Overall sales rose 4% in the third quarter, but the really good news comes from orders growth in its key HVAC segment. For reference, the HVAC segment generated $1.6 billion in profit in 2019 compared to $0.7 billion from fire and safety equipment, and $0.5 billion from refrigeration.
The residential HVAC market has been hot this year due to stay-at-home measures, which have encouraged people to spend more money on their homes. Indeed, Carrier's light and residential HVAC orders rose 60% year over year in the third quarter and offset flat commercial HVAC orders growth, leading to 25% growth in overall HVAC orders.
The strong growth in orders led management to raise guidance, again, in the third quarter.
|
Carrier Full-Year Guidance |
As of Oct-2020 |
As of Jul-2020 |
As of May-2020 |
|---|---|---|---|
|
Sales |
$17.3 billion |
$15.5 billion to $17 billion |
$15 billion to $17 billion |
|
Adjusted operating profit |
$2.2 billion |
$1.8 billion to $2 billion |
$1.7 billion to $2 billion |
|
Free cash flow |
$1.5 billion |
At least $1.1 billion |
More than $1 billion |
Data source: Carrier presentations.
The positive news is confirmed when looking at the numbers from HVACR distributor Watsco (WSO 1.49%). The company is a key partner of Carrier and the two have joint ventures together. In fact, Watsco makes around 62% of its purchases from Carrier.
As such, Carrier investors will be pleased to hear that Watsco reported 10% sales growth in HVAC in the third quarter with 19% growth in U.S. residential products -- suggesting more orders are likely for Carrier in the future. In addition, Watsco recently announced it has passed $5 billion in sales in 2020 -- slightly ahead of the analyst consensus.
Long-term considerations
Over the long term, all the usual arguments for the HVAC industry still apply. Rising incomes in the emerging world usually means increased demand for HVAC, while the global trend toward urbanization continues apace. Moreover, the higher-quality HVAC suppliers like Trane and Carrier have growth opportunities through adopting digital technologies in their solutions.
Image source: Getty Images.
Finally, the pandemic is likely to create increased demand for well-ventilated buildings, and Carrier's refrigeration solutions are set to benefit from COVID-19 vaccine distribution, particularly if it requires countries to build out cold chain infrastructure.
Carrier is a buy for 2021
All told, the stock is favorably positioned and attractively valued, with plenty of near-term and long-term earnings drivers in place. While the stock isn't going to have the same year as it did in 2020, I think there's still significant potential for gains in 2021. That might suit investors in a marketplace that is looking overvalued right now.
