Why This A/C Specialist Could Be the Hottest Industrial Stock

As I write, heating, ventilation and air conditioning (HVAC) company carrier‘s (NYSE:CARR) the stock is up almost 50% so far. Still, I think there’s more room to run. In its recent second quarter earnings report, management has raised expectations for the full year, and there are multiple reasons why the company could continue to surprise investors going forward. Here are three.

A couple enjoys air conditioning.

Image source: Getty Images.

Earnings momentum remains strong

Carrier entered 2021 and expected organic revenue 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 is a measure of the company’s progress this year that management has raised expectations for the full year to organic revenue growth of 10% to 12%, FCF of $1.9 billion and adjusted earnings per share of $2.10 to $2.20.

Carrier’s residential HVAC business was one of the big winners of the stay-at-home phenomenon as consumers focused on home improvement spending. You can see this in the strong recovery in residential and light commercial order growth from the third quarter of 2020. The good news in 2021 is that residential HVAC was bolstered by commercial HVAC, refrigeration and fire and security.

In short, Carrier benefited from the reopening economy. The following table shows the year-over-year order growth for its business segments for the past five quarters,

Business segment

2nd quarter 2021

1st quarter 2021

4th quarter 2020

3rd quarter 2020

2nd quarter 2020

HVAC

30%-35%

40%-45%

10%

25%

(5%)

Residential and Light Commercial

>30%

>60%

20%

60%

5%

Commercial break

>30%

>15%

0%

0%

(15%)

cooling

50%-55%

35%-40%

40%

15%

0%

Fire and Security

25%-30%

5% -10%

5%

(10%)

(25%)

Total

35%

30%-35%

15%

15%

(10%)

Data source: Carrier presentations.

Rising revenues is one thing, but most industrial companies have reported cost pressures from rising raw material costs. Carrier was also hit. For example, management’s Carrier 700 program — a plan to reduce 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 2021 (as part of the Carrer 700 plan) would likely be only $150 million due to headwinds of $75 million in additional costs.

Regardless of; management plans to offset cost pressures by implementing price increases. The plan is for $125 million in price increases, which will offset increased costs of $75 million and an additional $50 million in additional freight costs and plant inefficiencies due to COVID-19.

The bottom line is that Carrier’s price increases offset the cost increases. That’s part of the reason why the full-year adjusted operating margin is now expected to be greater than 13.5%, compared to an estimate of “about 13.5%” on the earnings call for the first quarter.

air conditioning units.

Image source: Getty Images.

Renewed focus on HVAC

Carrier is a company that grew out of the breakup of United Technologies. One of the key benefits of operating as an independent company is that Carrier management is now fully responsible for the company’s fate and can focus on developing its HVAC business. So it was not surprising that Carrier agreed to sell its Chubb fire and security business for an enterprise value of $3.1 billion (net after-tax revenue 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 noted during his company’s earnings call that it was “a very nice price” with a “very high multiple.”

Carrier CEO Dave Gitlin plans to use the money to make “acquisitions, repurchases and debt repayments in 12 to 18 months” – further proof of management’s strategic positioning to focus on the exciting growth potential in the HVAC industry.

Air conditioning maintenance.

Image source: Getty Images.

Long-term growth prospects

Carrier has good short-term earnings growth potential as well as excellent long-term potential. Moreover, that potential has arguably been increased 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 raised awareness of the need for proper ventilation in commercial buildings.
  • Buildings and air conditioning are a major source of carbon emissions, and high-performance HVAC companies such as Carrier, Johnson Controls, and Trane Technologies have the opportunity to take advantage of retrofits as building owners strive to reduce emissions.
  • Carrier continues to invest in digital/IoT solutions to increase recurring aftermarket revenue through Carrier technicians (rather than an independent company) servicing Carrier equipment.

Look forward to something

A combination of short and long-term growth opportunities plus management’s strategic initiatives make Carrier a very attractive stock for investors. The strength of the order book suggests Carrier could continue to grow strongly in the post-pandemic environment, and it wouldn’t be surprising if management saw earnings expectations improve again in 2021.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium consulting service from Motley Fool. We are fur! Questioning an investment thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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