This HVAC Stock Is a Buy. It Represents the Future of the Industry.
If you can’t beat ’em, copy ’em—and that’s exactly what Carrier Global CARR +3.11% , the maker of heating, ventilation, and air conditioning products, is doing.
Carrier (ticker: CARR), based in Palm Beach Gardens, Fla., has grown earnings at a more-than-respectable 19.4% a year on average over the past three years. The stock has returned 6.1%, including reinvested dividends, over the past 12 months, 10 percentage points more than the S&P 500 indexSPX +1.85% , and fetches less than 16 times 12-month forward earnings, well below the S&P 500’s 18 times.
What Carrier hasn’t been able to do is keep up with a Wall Street darling, Trane Technologies TT +0.46% (TT), at least when it comes to HVAC stocks. Carrier is growing fast, but Trane is growing even faster—its earnings increased at a 28.5% clip over the past three years, and the stock returned 26.8% over the past 12 months. Trane also fetches 20.4 times 12-month forward earnings, a sign of just how much more investors seem to value it relative to Carrier.
Carrier stock might now be poised to close that gap. On April 25, the company announced the acquisition of Viessmann Climate Solutions, a leading German maker of heat pumps and other climate-control products, for 12 billion euros, or about $13.2 billion, in cash and stock. Carrier also plans to exit most of its refrigeration, fire, and security businesses, leaving it looking like a closer facsimile of Trane when all is said and done.
Investors didn’t seem to like the deal, even though it should boost sales growth by at least a percentage point, to about a 5% annual average from 4% in coming years, while boosting profit margins by one to two percentage points. Carrier stock dropped 10% from April 24, when the deal was first reported, through April 26, after it was confirmed. The big issue is likely that Carrier expects to make less money on a per-share basis in 2024 than it would have if it had not done the deal.
RBC Capital Markets analyst Deane Dray thinks the concerns are overblown. He estimates the deal will reduce earnings by only five cents a share or so—from $2.80 to $2.75—or about 2% of predeal estimated earnings due to the increased share count. “Overall, we are fans of Carrier’s decision to transition to an HVAC pure-play with an attractive energy transition turbocharger,” he wrote in a recent research report.
Heat pumps are that turbocharger. A heat pump is like an air conditioner, but more efficient, and can both cool and heat using electricity. They are the electric vehicles of HVAC and will go a long way to reducing carbon-dioxide emissions. All told, replacing all HVAC systems in U.S. single-family homes with heat pumps would cut roughly as much carbon as putting 60 million Teslas on the road. Carrier’s HVAC business is expected to hit $15.1 billion in 2023, up from $13.4 billion in 2022.
If Carrier is overpaying for Viessmann, it isn’t by much. The deal values the latter at about 17 times 2023’s expected earnings before interest, taxes, depreciation, and amortization, or Ebitda. Include the expected cost synergies, and the multiple drops to about 13 times, a touch above Carrier’s own 11 times. “This looks like an attractive deal, especially in how it accelerates Carrier’s pure-play HVAC transformation,” wrote Dray.
The success of the deal could come down to how well CEO David Gitlin and Chief Financial Officer Patrick Goris execute. It will be their job to integrate Viessmann and manage the new debt load, which will be around 3.5 times Ebitda. If all goes as planned, Carrier should be generating more than $22 billion in annual revenue and about $3.7 billion in Ebitda, against $13 billion in debt. With $4 billion of free cash flow over the next two years, Carrier’s balance sheet should look similar to Trane’s by 2025.
If the market sees the same thing, Carrier shares could be worth $57 trading at a Trane-like multiple, up 40% from a recent $41.10. Dray, who rates Carrier Outperform, has a more conservative price target of $48 a share, up 17%. Dray’s price works out to about 17 times his estimated 2024 earnings, putting his target multiple between Carrier’s existing price/earnings ratio and Trane’s.
Either way, Carrier looks better positioned today than it was a week ago. Investors just haven’t bothered to pay attention yet.