The market reacted badly to heating, ventilation, and air conditioning (HVAC) company Carrier Global's (CARR -1.84%) recently released fourth-quarter earnings report. The market can be wrong, though. It's never great news when a company misses analyst earnings estimates, and it's even worse when it guides toward year-ahead earnings that disappoint compared to the analyst consensus. However, the details are important: The reasons behind these events are actually positives for the company, and investors should warm to them. Here's the lowdown.
Carrier's fourth-quarter earnings
In a nutshell, Carrier faced some higher-than-expected one-time item costs and made investments to fuel future growth in the fourth quarter. However, its sales were pretty much in line with management's previous guidance, and adjusted operating profit was actually slightly ahead of projections.
Digging into the details, adjusted operating profit came in at $453 million in the fourth quarter and $2.23 billion for the full-year. These figures came in ahead of management's guidance for $2.2 billion, and they included "$75 million of investments, about $25 million of incremental public company costs and about $50 million of one-time items in the quarter," according to CFO Patrick Goris on the earnings call. While management anticipated most of these costs, Goris said the one-time items were "$20 million higher than we expected."
If you add the $20 million back to the full-year figure of $2.23 billion it comes to a rounded figure of $2.36 billion, a number notably ahead of the $2.2 billion forecast. As such, it looks like this is a case of Wall Street being too optimistic with earnings forecasts. And Carrier actually exceeded its own guidance.
Investors will feel even more positive about the fourth-quarter earnings when they consider that the biggest item in the $50 million of one-time items came from costs associated with terminating an unfavorable vendor contract that was originally created when Carrier was part of United Technologies.
Full-year 2021 guidance
Wall Street was expecting $1.93 in adjusted earnings per share (EPS) for 2021, but Carrier guided toward a range of $1.85-$1.95. In other words, the midpoint of management's guidance ($1.90) implies a figure below what Wall Street was expecting.
However, here again, it pays to listen to what management is saying on the matter. Speaking on the earnings call, Goris said that the previous plan was to invest $100 million in the business in "each year of 2020, 2021 and 2022," but that management decided to pull forward $50 million of investment into 2021. The end result is $150 million of investment in 2021 -- and management "currently expect[s] incremental investments in 2022 to be only $50 million"
Clearly, this means $50 million more in non-capital investment in 2021, a figure that equates to slightly more than $0.04 in EPS. If you add that back to the guidance range above, you get $1.89-$1.99, the midpoint of which is above the analyst consensus for 2021 going into the results.
More investment means more growth
In addition, Carrier's investments should be welcomed by investors, particularly as they tie in with the rationale for the split from United Technologies. CEO David Gitlin outlined that Carrier added 550 sales and support people in 2020, a figure that's 50 more than originally planned. Furthermore, investments in research and development helped Carrier release 120 new products in 2020, including residential air purifiers.
Finally, management's plan to focus on growing its recurring revenue with aftermarket sales will receive a boost due to investment in digital technology, particularly technology tied to healthy buildings within its core HVAC segment.
Good earnings momentum
Guidance calls for organic sales to increase 4%-6%, with favorable foreign exchange movements of 2% translating into a 6%-8% reported sales increase in 2021. And margin expansion is expected to lead to an 11%-17% increase in EPS to $1.85-$1.95, as discussed previously. Meanwhile, free cash flow is expected to be $1.6 billion.
The good news is that Carrier's order trends suggest it will have good sales momentum in the first half of the year. The strength in HVAC orders is coming from a resurgent housing market, though investors will want to see improvement in commercial HVAC growth. Meanwhile, refrigeration looks set for a strong 2021 (management predicts low-teens organic sales growth), and fire & security is recovering from the COVID-19 pandemic.
Carrier Orders Year-Over-Year Growth |
Q4 |
Q3 |
Q2 |
Notes on Q4 |
---|---|---|---|---|
HVAC |
10% |
25% |
(5%) |
Residential & light commercial orders up 20%, commercial HVAC 0% |
Refrigeration |
40% |
15% |
0 |
Transportation orders up 50%, commercial up 20% |
Fire & Security |
5% |
(10%) |
(25%) |
N/A |
Total |
15% |
15% |
(10%) |
N/A |
Looking ahead
All told, the market has overreacted to superficially bad news from the earnings report, but the reality is that Carrier is still set to grow earnings and free cash flow at a mid-teens rate over the next couple of years, and the investments it has made to fuel growth in its HVAC sales hold out the promise of long-term improvement in profitability. Trading at around 20 times estimated 2021 free cash flow, Carrier remains an excellent value stock.