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Heating, Ventilation and Air Conditioning (HVAC) stocks were an interesting industry even before the 2020 crisis year, with Barron’s highlighting the sector’s potential in 2019. Now, with the ongoing pandemic and reports that schools, offices, retail establishments and restaurants all seeking to improve and upgrade their ventilation systems, it appears to be an ideal time to assess how investors can participate in this sector.
HVAC Stocks and the “Healthy Buildings” Theme
On March 18th, 2021, Axios reported on the need to upgrade school ventilation systems, one of many such articles that have been written on the topic of the need for improving ventilation.
As schools figure out what they need to do to safely resume in-person classes, some experts are advocating for options — like better air filtration — that would yield added benefits beyond the pandemic…54% of public school districts have outdated ventilation systems, a 2020 GAO analysis says….Schools can use COVID relief funding to upgrade those systems, among other modifications.Better ventilation may help schools beyond the pandemic, Axios
This news item caught our attention as particularly intriguing. While HVAC stocks were already set to gain business from private industries seeking to upgrade their ventilation systems, these companies may also be poised to benefit from high-priority public and government institutions investing to make their buildings safer for schoolchildren and employees.
These developments make HVAC stocks potentially appealing beneficiaries of planned stimulus and infrastructure spending. But like with any investing theme, investors need to dig into to the details of individual companies to see how their business is or is not taking advantage of this potential catalyst.
Risks to Investing in HVAC Stocks
Investing in any theme is challenging; the theme may or may not play out as expected. Picking individual companies that will benefit from the theme comes with individual stock risk. The HVAC stocks below are part of the industrial sector, which is particularly sensitive to cyclical economic conditions, supply chain challenges and raw materials inflation. HVAC companies also have multiple business lines and sales channels, including serving retail customers, which comes with added risks and challenges.
Notable HVAC Stocks: Carrier, Trane and Johnson Controls
Below are some of the largest and most notable “pure play” HVAC stocks.
Carrier Global Corp. (CARR)
Carrier is an industry leader and one of the more obvious choices for exposure to the HVAC theme. The company has three main business lines: HVAC, refrigeration and fire & security, with HVAC making up more than half of the company’s revenues.
The company was spun off from United Technologies in April 2020 as a focused HVACR business. To say 2020 was a challenging first year to debut as a public company is an understatement! The company started its life under pressure from a heavy debt load as well as challenges with profit margins and supply chain issues that impacted most major manufacturers. According to Morningstar, many of these issues have improved, with the company raising cash through equity sales to help reduce their debt load.
In terms of key financial metrics, the $37B market-cap stock trades at $42.32 per share at the time of writing and offers a 1.13% forward dividend yield. The stock has been a standout performer in its short life, returning just over 200% in the past 12 months, far outpacing the industrial sector during the same time period, according to Morningstar data. JP Morgan industrials analyst Stephen Tusa called Carrier a “once in a cycle” opportunity when he initiated coverage on the stock in April 2020, and has since become more neutral on the stock as a result of
In terms of the broader theme, Carrier’s executives have repeatedly emphasized their role in developing “healthy” buildings and the potential tailwinds from organizations and individuals placing a higher emphasis on ventilation.
While the COVID pandemic in 2020 presented unprecedented challenges, it also served to reinforce our position as the world leader in healthy, safe, and sustainable building and cold chain solutions….As COVID shined a light on the criticality of healthy, safe, and sustainable buildings and cold chains, we acted on our ambition to become a world leader in both. There has been a tectonic shift in how business, government, and society value the safety of indoor environments, and the importance of robust systems for distributing food and medicine.Carrier CEO David Gitlin, Q4 2020 Earnings Conference Call
And more to the point, Carrier has pointed towards specific product lines that are benefiting from the theme:
On the building side, we introduced new products like our OptiClean unit that Time Magazine recognized as a top innovation of 2020. More recently, as part of our healthy home strategy, we introduced an air purifier for the home. This is our first direct to consumer product focused on improving air quality. And we also are now selling Carrier one-inch filters directly to consumers. Overall, we have over $100 million of orders for healthy building products and services, and have a pipeline of more than $200 million.Carrier CEO David Gitlin, Q4 2020 Earnings Conference Call
Like most HVAC stocks, Carrier faces continuous cost pressures in developing new models of their equipment that comply with upgraded government standards, including a minimum efficiency change in 2023 affecting residential and light commercial units.
Potential investors will need to research if Carrier can continue to benefit from the sector’s tailwinds after such an enormous run up in the stock over the past year.
Trane Technologies (TT)
Trane Technologies is another large player in the HVACR space, a $12.5B market-cap company that generates about 70% of its business from equipment and 30% from parts and service. Trane currently trades for $169.55 per share and offers a 1.39% forward dividend yield, after appreciating more than 87% in the past 12 months.
Trane has also actively sought to position itself among the companies set to benefit from healthy schools and workplaces and related ventilation upgrades.
We are also acutely focused on indoor environmental quality to improve the health and safety of indoor spaces. And we believe this is another long-term secular mega trends impacting our industry laid bare and amplified by the pandemic. This is especially critical in education where many children rely on schools for access to technology and food.
Virtual learning is broadening the digital divide and having a disproportionate impact and indigenous students and the students of color. It’s vital that we open our schools and address an equity in our educational systems.
We are applying our expertise and solutions to improve indoor air quality and commercial and residential spaces and balancing that with strategies to improve energy efficiency and reduced emissions. All of this was part of our drive to create a new better normal.Trane Technologies CEO Mike Lamach, Q4 2020 Earnings Call
Like Carrier, Trane will seek to benefit from a desire to improve indoor air quality (IAQ) through smarter building ventilation systems. Trane also has put sustainability front and center of their brand, including through its Gigaton Challenge, launched in 2019 to reduce customers’ carbon emissions by one gigaton by the year 2030. According to Sustainalytics, Trane ranks #2 out of 127 companies in the building products industry group for its ESG risk rating.
Trane also is prioritizing their mobile refrigeration services to enter the vaccine transportation business, with its cold storage solutions key to keeping RNA vaccines viable at ultra-low temperatures.
Johnson Controls International (JCI)
Johnson Controls International is a large, $44B market-cap company focused on HVAC, refrigeration, fire and security solutions for buildings. The stock currently trades at $61.76 per share, with a 1.75% forward dividend. Their commercial HVAC business line makes up about 40% of sales, with an additional residential HVAC business line contributing to their overall $22B in revenues in 2020.
Like its peers in the space, Johnson Controls is focusing on the healthy building theme through its OpenBlue Healthy Buildings initiative:
We launched seven new offerings this quarter, the most significant of which is OpenBlue Healthy Buildings, the industry’s most comprehensive suite of connected solutions. This particular launch leverages the strength of our core capabilities, which together with data-driven AI technologies enables our customers to transform how people interact with their buildings, create intelligence, safe dynamic environments, achieve their own green building goals and maximize return on investment with shorter paybacks.
By combining these solutions, we create a holistic menu of offerings that prevent customers from having to choose between efficiency and sustainability. We now have 27 offerings available that solve for unique customer problems and serve a new market opportunity, which we size at $10 billion to $15 billion and is growing at a double-digit CAGR over at least the next five years. We are ideally positioned with technologies and solutions that accelerate the transformation and reinvention of Healthy Buildings, which is directly aligned with the priorities of the incoming U.S. administration.Johnson Controls CEO George Oliver, Q4 2020 Earnings Report
Johnson Controls stock has returned more than 105% over the past 12 months according to Morningstar data. The company continues to focus on cost management while developing new product lines that align with a focus on healthier ventilation and sustainable HVACR solutions to office and residential building design.
The above are three ideas for investors to research to gain exposure to HVAC demand and the theme of healthy buildings.