Given that buildings emit nearly 40% of the world's carbon emissions, companies must invest in smart, healthy, and sustainable buildings if they want to meet their environmental, social, and governance (ESG) commitments. That's where companies like Johnson Controls (JCI 1.30%), Honeywell (HON +0.55%), and Siemens (SIEGY 1.61%) come in. All three can grow profits significantly from helping companies meet their ESG goals. Here's the how and why.
Healthy buildings
Alongside the long-term need to create net-zero carbon emissions, the COVID-19 pandemic has created a heightened sense of awareness around the need to ensure buildings are "healthy." The latter usually means ensuring good air quality and ventilation. As such, heating, ventilation, and air conditioning (HVAC) companies such as Carrier (CARR 2.09%) and others, including Johnson Controls, are an excellent way to get exposure to the theme. Indeed, they have all been reporting strong orders growth in commercial HVAC orders this year.
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In addition, Honeywell's building technologies (HBT) segment, a provider of products and services for building control and energy management, has been aggressively growing orders under the theme of "healthy buildings."
Johnson Controls' management sees the healthy buildings theme as a market worth some $10 billion to $15 billion. However, its management sees an opportunity to address a net-zero buildings emissions market of around $240 billion over the next decade, "and that's above the $300-plus billion market that we serve today," said Johnson Controls CEO George Oliver on the last earnings call.
Who will benefit and why
The three companies discussed here have varying degrees of exposure, but what they all have in common is an aggressive approach to integrating digital and connected technology at the heart of their solutions.
Through the Internet of Things (IoT) connectivity, building owners can gather a mass of data from their buildings and use artificial intelligence and data analytics to make them more energy efficient while reducing carbon emissions. Johnson Controls' collection of digital solutions, called OpenBlue, enables building owners to create performance dashboards that give real-time reports on energy and greenhouse gas emissions.
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Meanwhile, Honeywell's enterprise performance software as a service (SaaS) business, known as Honeywell Forge, allows building owners to collect data and digitally manage them, therefore improving performance.
The Siemens smart infrastructure (SI) segment generates nearly half of its revenue from buildings, including building management systems, HVAC controls, and energy and performance services. It competes directly with Honeywell and Johnson Controls. In addition, Siemens' management is openly seeking acquisitions in the smart software arena to boost growth and grab market share. Given the company's substantive cash flow generation, pristine balance sheet, and existing world-class industrial software capability, it's hard to bet against it happening.
Why it's a game-changer
The purest way to play the theme is through investing in Johnson Controls. Its combination of HVAC, building controls, refrigeration, fire, and security solutions makes it a significant player in the environment component of the ESG investing theme. It's something management has positioned the company for following the spin-off of its automotive business, Adient, in 2016 and the sale of its power solutions (car batteries) business in 2019.
Siemens' SI segment only generated 19% of the company's industrial business profit in the first three quarters of 2021. However, management plans to increase the segment's profit margin from 6.9% in 2020 to a range of 11%-16% over the medium term. In addition, the focus on growing software and digital revenue is representative of the company's shift toward higher-growth industries. It's a transformation that doesn't appear to be reflected yet in the stock's discounted valuation.
Honeywell's HBT segment only contributed 16.5% of segment earnings in 2020, so it's arguably the least exposed to the theme. That said, investing is often about focusing on the business that can make the marginal difference to profit growth. Indeed, management has already upgraded its full-year sales growth expectations for HBT from low-single-digit growth to mid-single-digit growth.
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Moreover, the HBT segment was previously a battleground between bulls and bears. The bears were fearful that the lingering impact of COVID-19 would cause a slump in commercial building spending, while the bulls focused on the reopening opportunity and the healthy buildings theme. It looks like the bulls are winning.
Looking forward
All told, the movement toward net-zero carbon emissions is gathering steam. It provides a significant opportunity for all three companies as building owners seek to retrofit buildings and integrate smart technology in new buildings. Throw in significant enhancements in smart digital technology, and building owners will see tangible cost advantages in buying solutions from Johnson Controls, Honeywell, and Siemens in the future.
