The case for buying stock in elevator and escalator company Otis Worldwide (OTIS 0.73%) was undoubtedly strengthened following an excellent set of second-quarter earnings. Still, was it enough to make the stock a buy? To help answer that question, here's a look at the key factors behind the investment case for buying the stock.
The case for buying Otis stock
The three highly interconnected reasons are all based on the fact that Otis is ostensibly focused on its service business. While its equipment business (elevators and escalators) is higher-profile, servicing the installed equipment makes more money. For example, the service business generated $884 million in adjusted operating profit in the first half with a 22.5% margin, compared to equipment's $264 million with an 8.3% margin. Whichever way you look at it, service is what counts for Otis.
This point is implicitly recognized in the case for buying Otis' stock:
- To grow service revenue, Otis aims to grow new-equipment market share in China, the biggest elevator/escalator market globally.
- Management plans to improve service levels, particularly in China, through hiring and technological deployment (such as handheld Internet of Things -- or IoT -- devices).
- Otis is increasingly embedding IoT capability in its new equipment to improve its service and better retain customers.
The good news is Otis made progress on all three fronts in the quarter, which leads to the three reasons to buy its stock.
1. It's winning market share
On a worldwide basis, Otis grew organic sales by 15.4% in the second quarter, with new equipment sales up a whopping 25.4% and service sales up 7.8%. The company came up with some relatively easy year-over-year comparisons in the second quarter (the same period in 2020 is when the lockdowns initially hit the global economy). Still, management is expecting full-year 2021 new-equipment organic sales to rise 12% to 13%, with organic service sales up 4% to 4.5%, resulting in overall organic sales growth of 7.5% to 8%.
Equally important, during the earnings call, CEO Judy Marks said that Otis gained "about 1 point of new-equipment share" globally. And CFO Rahul Ghai declared himself "very pleased" with performance in the key China market, saying, "as we came through the quarter, record orders in the mid-teens. So very pleased with that double-digit sales, and the team grew our portfolio mid-teens. So we gained share."
2. It's improving service revenue down the line
Wining new-equipment market share is one of the keys to growing the number of units under maintenance and ultimately expanding its service revenue. Indeed, Otis grew its maintenance business by an impressive 3% in the second quarter. It might not sound like a huge figure, but if the digital initiatives take off and management pushes through planned price increases, it could mean mid-single-digit growth in high-margin service revenue in the future.
Moreover, Otis continues to invest in capturing market share in China. Marks said that another 150 agents were added in the country in the quarter, taking Otis up to 2,150, and she claimed that Otis was winning market share in " Tier 1 and Tier 2 cities, which is where we were not performing as well as we needed to."
The evidence is that Otis is winning the strategic battle to position itself for services growth, particularly in China.
3. Digital initiatives
During the earnings call, Marks declared that Otis was all-in on IoT-enabled technology. In a nutshell, the idea is that its Otis One IoT platform will continuously gather real-time data from elevators to generate insights to improve performance. In addition, Marks said that Otis would roll out 100,000 IoT-enabled units in 2021.
It's still the relatively early days, but Otis' digital initiatives offer a real long-term growth opportunity.
A stock to buy?
Otis' performance has been better than expected in 2021, and Marks said she would release a revised midterm outlook on all the metrics in early 2022. Don't be surprised if it's an upgrade. Moreover, the long-term growth prospects from digital initiatives, expanding units under maintenance, and growing market share are on track.
Trading at 28 times forward earnings, Otis is not a cheap stock, and most investors won't see it as being a great value.
However, if you are bullish on long-term growth prospects on construction in China and Otis' global growth initiatives, the stock presents an excellent way to gain exposure. As such, it has a place in a China bull's portfolio.