Many people are rightly confused about the direction of the economy, as economists and CEOs give mixed messages. On the one hand, Bank of America (BAC) CEO Brian Moynihan recently stated that nothing could stop the American consumer from spending money, while JPMorgan Chase (JPM) CEO Jamie Dimon is telling everyone to prepare for an “economic hurricane”.
It is therefore not surprising that equities have been volatile over the past two months. What’s good for value investors, however, is that market uncertainty has presented a number of opportunities to layer on quality stocks that have been battered.
This brings me to Carrier Global (NYSE: CARR), which, as seen below, has fallen 27% since the start of the year. In this article, I highlight why CARR can be an attractive opportunity for strong long-term total returns from here, so let’s get started
Carrier Global is a leading manufacturer of heating, air conditioning, ventilation, refrigeration, fire and security products. Its HVAC business serves both residential and commercial markets, and its refrigeration segments serve the critical food transportation segment that is an integral part of the cold storage supply chain. Carrier was initially spun off from United Technologies, giving it carte blanche to chart its own course, and over the past 12 months has generated $20.6 billion in total revenue.
Carrier’s advantages include its strong global reach, with products in 160 countries, and its diverse product portfolio and end markets. In terms of competitive advantages, Carrier has over 100 years of industry experience, which has allowed it to develop a strong brand and reputation for quality.
In addition, Carrier also benefits from its aftermarket business, which provides spare parts and services and accounts for approximately 30% of total revenue. This business is much more profitable than new equipment sales because it has higher gross margins and also provides Carrier with a more predictable and visible revenue stream. As shown below, Carrier earns an A grade for profitability, with an industry-leading net income margin of 12.9%, well above the industry median of 6.7%.
Meanwhile, Carrier has demonstrated respectable fundamentals, with organic sales up 10% year-on-year in the first quarter (total sales down 1% due to Chubb divestiture). This was driven by HVAC segment strengths in residential, light commercial and North American building control systems, all of which were up 20% year-over-year. Also encouraging, Refrigeration sales increased by 1% despite a difficult comparison with record sales during the same period of 2021.
Awaiting second quarter results and beyond, I expect Carrier to post strong results, given the recent record-breaking heat wave in Europe, as well as above-normal temperatures in a large part of the United States. ventilation and air conditioning products. Risks to Carrier, however, include wage and cost inflation and increased competition, which could put pressure on its margins in the near term.
Nonetheless, Carrier has strong long-term prospects given its mostly pure focus and focus on service accessories and energy efficiency. This was highlighted by Morningstar in its recent analyst report:
Two of Carrier’s most high-profile growth initiatives include increasing its service engagement rate and becoming the applied HVAC market leader within five years. We believe Carrier will successfully increase its service revenue, and while we believe it can gain market share in the applied HVAC segment, we expect stiff competition from Johnson Controls and Trane Technologies.
We believe Carrier’s HVAC segment (its largest segment at approximately 60% of sales) has the greatest long-term growth potential due to its exposure to the commercial HVAC market. We expect the commercial HVAC market to grow above GDP due to increased demand for energy efficient and indoor air quality solutions.
Residential HVAC demand remained robust in 2021, but we have a cautious outlook. On the one hand, we expect housing starts to remain high over the next five years (returning to 1.6 million units per year by 2025 after slower construction activity, but above the historical average). in 2023-24) and regulatory changes (eg refrigerants and energy efficiency standards) should be a tailwind. On the other hand, we think the replacement cycle is coming of age.
Meanwhile, CARR maintains a strong BBB-rated balance sheet and pays a dividend yield of 1.6% which is well supported by a low payout ratio of 23%. Although the yield is weak, management has recently declared its intention to use the capital for acquisitions or share buybacks, while aiming for a payout ratio of 30% in 2023, thus signaling a significant increase in the dividend of here there.
I see value in the stock after the market has fallen for the past few months to the current price of $38.50 with a forward PE of 16.9. Sell-side analysts forecast EPS growth in the low to mid-teens for much of next year and have a consensus Buy rating with an average price target of $44.70. This translates into a potential total return of 18% over one year, including dividends.
Key takeaway for investors
In summary, Carrier is a high quality manufacturer with a strong market position, high profitability and should benefit from increased demand for its HVAC products. Although the dividend yield is low at the moment, an increase in the payout ratio next year could result in a significant upside. The recent selloff presents an attractive entry point for long-term investors.