As I write, heating, ventilation, and air conditioning (HVAC) company Carrier's (CARR +2.70%) stock is up nearly 50% year to date. Still, I think there's more room to run. The recent second-quarter earnings report saw management raising full-year guidance, and there are multiple reasons the company could continue to delight investors in the future as well. Here are three of them.
Image source: Getty Images.
Earnings momentum remains strong
Carrier started 2021 expecting organic sales growth of 4% to 6%, free cash flow (FCF) of $1.6 billion, and adjusted earnings per share (EPS) of $1.85 to $1.95. It's a measure of the progress the company has made this year that management hiked full-year guidance to organic sales growth of 10% to 12%, FCF of $1.9 billion, and adjusted EPS of $2.10 to $2.20.
Carrier's residential HVAC business was one of the big winners from the stay-at-home phenomenon as consumers focused on spending on home improvement. You can see this in the strong recovery in residential and light commercial orders growth from the third quarter of 2020 onward. The good news in 2021 is that residential HVAC was joined in strength by commercial HVAC, refrigeration, and fire and security.
In a nutshell, the reopening economy benefited Carrier. The following table shows year-over-year order growth for its business segments for the past five quarters,
|
Business Segment |
Q2 2021 |
Q1 2021 |
Q4 2020 |
Q3 2020 |
Q2 2020 |
|---|---|---|---|---|---|
|
HVAC |
30%-35% |
40%-45% |
10% |
25% |
(5%) |
|
Residential and light commercial |
>30% |
>60% |
20% |
60% |
5% |
|
Commercial |
>30% |
>15% |
0% |
0% |
(15%) |
|
Refrigeration |
50%-55% |
35%-40% |
40% |
15% |
0% |
|
Fire & Security |
25%-30% |
5%-10% |
5% |
(10%) |
(25%) |
|
Total |
35% |
30%-35% |
15% |
15% |
(10%) |
Data source: Carrier presentations.
Rising revenue is one thing, but most industrial companies have reported cost pressures from surging raw material costs. Carrier's been hit, too. For example, management's Carrier 700 program -- a plan to cut ongoing costs by $700 million by 2023 -- was hurt by rising costs. During the earnings call management outlined that the $225 million in cost savings originally planned for in 2021 (as part of the Carrer 700 plan) would likely be just $150 million due to $75 million of extra cost headwinds.
No matter; management is planning to offset the cost pressures by making price increases. The plan is for $125 million worth of price increases, which will offset the increased cost of $75 million and an additional $50 million worth of extra freight costs and plant inefficiencies due to COVID-19.
Bottom line, Carrier's price increases will offset the cost increases. That's part of the reason full-year adjusted operating margin is now expected to be greater than 13.5% compared to an estimate of "around 13.5%" on the first-quarter earnings call.
Image source: Getty Images.
Renewed focus on HVAC
Carrier is a company created out of the breakup of United Technologies. One of the key benefits of its operating as an independent company is that Carrier's management is now fully in charge of the company's destiny and can focus on developing its HVAC business. So it wasn't surprising to see Carrier agree to sell its Chubb fire and security business for an enterprise value of $3.1 billion (net after-tax proceeds will be $2.6 billion).
Sometimes it's more interesting to hear what competitors are saying about the deal, and Stanley Black & Decker's CEO Jim Loree commented during his company's earnings call that it was "a very nice price" with a "very high multiple."
Carrier's CEO Dave Gitlin plans to use the cash to make "acquisitions, buybacks, and debt paydown over 12 to 18 months" -- yet more evidence of management's strategic positioning to focus on the exciting growth potential in the HVAC industry.
Image source: Getty Images.
Long-term growth prospects
Carrier has good near-term earnings growth potential, and it has excellent long-term potential as well. Moreover, that potential has arguably been enhanced by the COVID-19 pandemic and other developments.
- Vaccine distribution has highlighted the need for cold chain distribution and refrigerated food products, which is good news for Carrier's refrigerated solutions.
- The pandemic has created a heightened awareness of the need for good ventilation in commercial buildings.
- Buildings and air conditioning are a major source of carbon emissions, and higher-quality HVAC companies like Carrier, Johnson Controls, and Trane Technologies have an opportunity to benefit from retrofits as building owners seek to reduce emissions.
- Carrier continues to invest in digital/IoT solutions to increase recurring aftermarket revenue via Carrier technicians (rather than an independent company) servicing Carrier equipment.
Looking forward
A combination of near-term and long-term growth opportunities plus management's strategic initiatives continues to make Carrier a highly attractive stock for investors. The strength of the order book suggests Carrier can continue to grow strongly in the post-pandemic environment, and it wouldn't be surprising to see management upgrade earnings expectations again in 2021.
