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Carrier Q3’23 Results Defy Volume Declines with Margin Expansion
Despite the macroeconomic challenges and the slowdown in residential construction, Carrier has achieved a robust year-to-date performance. Particularly, it demonstrated exceptional performance in the HVAC and Fire & Security segments, leading to organic revenue growth and an expanded operating margin.
Several favorable factors are boosting the HVAC segment, including the impact of the SEER and the Inflation Reduction Act, which are bolstering demand for higher-efficiency products. Moreover, the increased infrastructure spending on semiconductor fabs, EV manufacturing, and data centers is further contributing to the positive momentum, offsetting the effects of the decreasing volumes in residential units, which admittedly is a significant part of Carrier’s business.
With the HVAC sector becoming a larger part of the company, currently at 68% of total sales, we believe that Carrier will experience continued expansion in its operating margin profile, as a) aftermarket business continues to outpace overall growth and b) consumers continue to shift to higher energy-efficient products due to regulatory mandates and government subsidies offered around the world.
Source: Stratosphere.io (use coupon code STOCKOPINE for a 25% discount), StockOpine Analysis
Sales: In Q3’23, Carrier reported sales of $5.7B, marking a 5.1% increase. Notably, organic growth accounted for 3% of this rise, with an additional 1% attributed to currency translation and a 1% net contribution from Toshiba Carrier over one month (acquired in 2022). For the cumulative 9-month period, sales exhibited a 4% organic growth (11% on a total revenue basis), aligning closely with management’s projected range of low-single-digit to mid-single-digit organic revenue growth for 2023.
Source: Carrier Quarterly Earnings Release, StockOpine Analysis
While the pace of organic sales growth has moderated, the normalization in growth is expected, given that the exceptional performance witnessed in FY22 and FY21 was partially fueled by inflation-driven price increases and a robust construction market.
Profitability: Carrier reported an adjusted operating profit of $1.04B, reflecting a 21% increase compared to the previous year. This resulted in an adjusted operating margin of 18.2%, a notable rise from the 15.8% recorded in the prior year. Management attributes this expansion primarily to robust productivity enhancements and improvements in cost reductions.
Source: Quarterly Earnings Release, Koyfin (affiliate link with a 15% discount for StockOpine readers), StockOpine Analysis
While the company's Gross Profit historically resided within the range of 29%, it faced challenges in FY21 and FY22 due to inflationary pressures and constraints in the supply chain, leading to escalated prices for commodities and freight. The normalization of gross profit margin highlight that these pressures have begun to ease.
Furthermore, we are optimistic that there is potential for continued upward trend in profitability due to the expectation that aftermarket sales growth will outpace the overall company growth and due to the increasing revenue weight of the HVAC segment.
“We have significantly matured our productivity processes, so we will enter 2024 with even more rigor and detailed plans around our cost reduction activities, positioning us for further margin expansion next year and beyond. We also have confidence in continued growth driven in part by our aftermarket and recurring revenue traction” David Gitlin, CEO
Segment Highlights for Q3’23
Achieved 4% organic sales growth primarily driven by commercial HVAC, which ranks second in the sales mix behind residential HVAC.
High single-digit growth in commercial HVAC, 30% growth in light commercial and double digit growth in aftermarket sales.
North America residential HVAC sales declined in the low single digits due to low double digits decrease in volumes.
Overall revenues continued to benefit from price realization and a positive mix from the 2023 SEER.
Recorded an adjusted operating profit margin of 20.8%, a notable increase from the 16.7% of prior year, driving the majority of the company's operating profit expansion.
European commercial heat pump sales displayed a growth of 70% in Q3 and a year-to-date increase of 40%. Despite the short-term concerns about a potential decrease in heat pump sales in the EU due to fluctuating government policies, including subsidies changes, along with falling gas prices and sustained high electricity prices, long-term optimism remains. The EU aims to install 60 million heat pumps by 2030 (with an estimated installed base of 20 million in 2022), as heat pumps play a key role in enabling the clean energy transition.
“Residential heat pump penetration in Europe is only about 8%. And 21 countries have subsidies to support 2030 and 2050 decarbonization goals.” David Gitlin, CEO
HVAC orders decreased by 10% in the quarter, primarily due to declines in residential and light commercial HVAC, while commercial HVAC orders remained steady facing strong prior year comparable orders. Backlog remains strong, up over 40% over a 2-year period.
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Reported flat sales but a 3% organic sales decline (offset by a 3% benefit from FX), due to softness in transport refrigeration.
Transport refrigeration experienced a mixed performance. Global truck and trailer sales surged by high single-digits, driven by over 20% growth in European truck and trailer whereas the container sub segment declined by 25%.
Commercial refrigeration sales also declined by 10% in the quarter, though orders returned to year-over-year growth.
Management anticipates that the Refrigeration segment will return to organic sales growth in Q4.
Adjusted operating margin was 12% versus 12.8% in prior year, mainly due to volume decline in container and commercial refrigeration.
Fire & Security Segment
Recorded a 2% growth in sales, showing organic growth of 6%, partly offset by a 5% setback due to the KFI deconsolidation. The segment performed well, marked by high single-digit organic growth in industrial fire and security, along with mid-single-digit growth in the combined commercial and residential fire.
Achieved a historic high adjusted operating margin, reaching 18.3% Vs 16.6% in prior year; driven by volume leverage, productivity gains and price-cost efficiencies.
Reaffirmed full-year sales guidance, anticipating sales of $22.1B to $22.2B, with mid-single-digit organic sales growth.
Adjusted operating margin was revised to ~14.5%, up from prior guidance of 14%-14.5%.
Aftermarket sales: Sustained double-digit growth in the aftermarket sales bring Carrier closer to its goal of achieving aftermarket sales of +$7B by 2026.
Acquisition of Viessmann Climate Solutions: Acquisition is expected to be completed in early January 2024. Viessmann sales are up by ~18% year-to-date with heat pump sales up over 35%.
Planned exits: Management expects to announce signed agreements for Security, Commercial Refrigeration and Industrial Fire in the first quarter of 2024, highlighting that there is high interest from potential buyers. The combined capital market transaction of Residential and Commercial Fire is expected to be finalized by late spring 2024.
Source: Q4’23 Earnings Presentation
In conclusion, Carrier Corporation showcased strong performance in HVAC and Fire & Security segments, despite a decline in residential HVAC volumes. Although the overall HVAC orders dropped (a typical trend during new construction slowdown), the segment's strong backlog and the shift to higher-priced, energy-efficient products due to SEER transitions are anticipated to offset this impact.
Short-term regulatory fluctuations in Europe may cause volatility, but the company remains confident in the long-term market trends as Europe’s clean energy transition targets stay intact. Carrier is well-positioned to leverage these long-term market dynamics, indicating a promising outlook for sustained growth and resilience.
If Carrier sounds like an interesting company, be sure that to check the deep dive we released in May 2023 (Carrier: The Path to Becoming a Global Climate Champion).