According to SEC filings, hedge funds were buying more shares in aviation-giant Boeing (BA -2.87%), heating ventilation and air conditioning company Carrier Global (CARR -0.67%), and elevator company Otis Worldwide (OTIS -4.21%) in the fourth quarter. Should investors follow their lead now, or is the party over for these three stocks?
Recent performance
A quick look at their performance shows that Boeing has outperformed the S&P 500 index on expectations of a recovery in air traffic as the vaccine rolls out and positive news flows on orders for the 737 MAX aircraft. Carrier and Otis -- two companies created out of the former United Technologies -- have not fared quite as well, but Carrier has managed to outpace the S&P 500 as of this writing as its stock has been up and down throughout the year.
Data by YCharts.
Boeing
The case for buying Boeing could be based on the idea that "it couldn't get much worse, could it?" That's a way of saying that the stock looked like an excellent value compared to the doom-and-gloom scenarios that the market had baked into the stock prices of aviation stocks at the start of the year.
That said, there are plenty of stocks available for investors looking at a recovery in commercial air traffic. Boeing is an option, but to buy it, you have to believe that the 737 MAX will start to win orders over the Airbus A320 family of aircraft. For reference, the two narrow-body airplanes are the commercial-aviation industry's workhorses.
The chart below shows the destruction in orders caused by the high-profile crashes that caused a grounding of the 737 MAX in 2019 and then the COVID-19 pandemic.
Data source: Boeing and Airbus presentations. Chart by author.
Not only does Boeing need to win orders, but it also needs to avoid cutting the price heavily in a fiercely competitive market. This is all the more important considering the company's heavy debt load, which it has amassed in recent years. Higher interest payments will encumber Boeing, as a result.
Data by YCharts.
All told, the aviation sector is an excellent place to invest, but there are better ways to play it than buying Boeing and taking on the added risks involved. Revenue from 737 MAX could disappoint in the coming years.
Otis Worldwide
Otis is the world's leading escalator and elevator company. The investment case for buying this company rests on the idea that it can win market share in the highly fragmented and lucrative services market and, in particular, in China, the world's largest elevator market. New equipment growth is significant, but that's mainly because it usually leads to service contracts.
For example, the new equipment segment profit margin was just 5.9% in 2020 with an operating profit of $318 million. By comparison, the service segment profit margin was 21.8%, with an operating profit of $1.6 billion.
Management has aimed to win back share in China in recent years while investing in digital technologies to differentiate itself from the competition in the services market. For example, mobile devices are being given to service personnel to quickly assess problems and order parts. Also, Otis is adding internet of things (IoT)-equipped elevators so performance can be remotely monitored and diagnosed.
Image source: Getty Images
According to CEO Judy Marks on the earnings call in February, Otis began "shipping new equipment units enabled with our IoT platform, Otis ONE. This year, we'll expand this offering to include shipping IoT-enabled units in the US, Asia-Pacific, and EMEA."
Analysts have Otis generating $1.37 billion and $1.44 billion in free cash flow (FCF) in 2021 and 2022, respectively, putting the stock at 21 times and 20 times its forward FCF. That's a reasonable valuation for a company with such exciting growth prospects.
Carrier
HVAC-company Carrier started 2021 with flying colors, as investors warmed to the company's combination of cost-cutting measures and growth initiatives. In a nutshell, the thesis behind buying the stock is that management has an opportunity to significantly grow earnings now that the company's free from being under the United Technologies umbrella.
Unfortunately, that thesis received a shock in February upon releasing a set of fourth-quarter earnings that came in lower than expected. Full-year guidance also came in lower than many had expected, and the stock sold off.
Image source: Getty Images.
However, the devil is in the details. The reasons for the disappointing earnings and guidance came down to a combination of unexpected one-time item costs and accelerating some of its growth investments in 2021. The one-time item costs largely came down to costs associated with terminating an unfavorable vendor contract.
After adjusting for these events, Carrier beat its guidance for 2020, and earnings guidance for 2021 was ahead of Wall Street's expectations. Carrier is trading at 21 times expected FCF in 2021, and analysts are expecting mid-teens growth in FCF over the next few years, so the company remains a good value option.
All told, Otis is an option if you're bullish on China. Boeing is probably not the best way to invest in an aerospace recovery, leaving Carrier looking like the best buy of the three.
