This Red-Hot Industrial Stock Looks Like a Good Value

There aren't many industries that have seen conditions significantly improve through 2022, but in the commercial building products sector, they have. In particular, current indicators in the HVAC (heating, ventilation, and air-conditioning) and building controls markets bode well for the upcoming earnings season. Investors looking to pick up bargain stocks will want to take a close look at Johnson Controls (JCI -0.86%) and, to a slightly lesser extent, keep an eye on Carrier (CARR -0.67%) and Trane Technologies (TT 0.47%).

Johnson Controls can regain investors' trust 

I'm singling out Johnson Controls for two reasons. First, it has relatively high exposure to products in the commercial HVAC (41% of its sales in 2021, compared to just 13% for residential HVAC) and fire and safety (39% of sales in 2021) categories. Second, the company looks particularly interesting as an investment because its fall from grace in 2022 (it has underperformed key peers Carrier and Trane) came partly as a consequence of disappointing investors earlier in the year. 

In a nutshell, management's initial guidance for its fiscal 2022 proved too optimistic, and the company was compelled to dial it back throughout the year. Having started its fiscal year with official guidance for earnings per share (EPS) in the range of $3.22 to $3.32, it's now forecasting EPS in the range of $2.98 to $3.02.

Data by YCharts

However, it's essential to understand why management cut that guidance. The company is finding it much harder than expected to deliver on its backlog due to supply chain challenges -- not the least of which involves procuring semiconductors for its higher-margin technology solutions, such as control products. CEO George Oliver noted on the May earnings call that the company's profit margins were lower than expected because it could not produce its control products in the quantities it had hoped to.

That said, the reality is that Johnson Controls' order backlog has increased enormously in recent quarters. In fact, as of June 30 (the end of its fiscal third quarter), its backlog stood at a record $11.1 billion.

Data source: Johnson Controls presentations. 

Strong sector

However, it's not just Johnson Controls that is seeing strength in its end markets in 2022. In its SEC filings, it points to companies such as Carrier and Trane as key competitors on the HVAC side. And on the building controls and software front, Honeywell and Siemens have segments that compete with it. The good news in 2022 is that all of these businesses have been reporting strong sales and order growth. That bodes well for Johnson Controls' upcoming quarterly numbers. 

While some are concerned that the residential HVAC market is going to roll over as interest rate hikes weaken the housing market, so far, at least, the mood in the commercial HVAC market remains bullish. For example, Trane's commercial HVAC bookings/orders rose by a mid-teens percentage in the Americas, a high-teens percentage in the Asia Pacific, and a low-teens percentage in Europe, the Middle East, and Africa (EMEA) in its second quarter. It's a similar story at Carrier where management reported that the second quarter was its "sixth consecutive quarter of double-digit order growth in Commercial HVAC." 

Turning to building controls, Honeywell's management reported double-digit percentage growth in orders and backlog in its second quarter for its Honeywell Building Technologies (HBT) segment. In addition, HBT revenue was up 14% organically in the same quarter. Its momentum in that segment is building -- management has twice upgraded its guidance for full-year organic sales growth in 2022. After starting the year forecasting high-single-digit percentage growth, management now expects double-digit percentage growth. 

Meanwhile, Siemens's smart infrastructure segment (around 45% of which is smart building management systems and software) has enjoyed robust revenue and orders growth so far this year.   

Data source: Siemens presentations. YOY = year over year.

Looking ahead 

That strong performance can largely be traced to the fact that property owners need to retrofit their commercial buildings, both to meet their carbon emissions reduction goals and to benefit financially from the dramatically increased efficiency offered by the digital technology of Johnson Controls and its peers. 

If this momentum can be maintained through 2022 and supply chain issues ease, then the HVAC and building products sector will have a good year, and Johnson Controls at its current share price should prove to be an excellent value.