Carrier: The Path to Becoming a Global Climate Champion
Carrier: The Path to Becoming a Global Climate Champion
Every month we share 2 write-ups on companies we decided to examine as potential additions to our portfolio. Although the companies analysed may tick most of the boxes, if the margin of safety is not considered sufficient, we will not initiate a position but rather monitor the stock.
In case we decide to initiate a position at any time, we will share an Investment Thesis memo. For any additions to existing positions we will update you through our Quarterly Portfolio Updates.
1. Key Facts
Description: Carrier Global Corporation (“Carr”, “Carrier”, and “Company”) is the leading manufacturer of heating, ventilation and air conditioning (HVAC), refrigeration, fire, security and building automation equipment.
Key Financials: Over the period FY17 to trailing twelve months (“TTM”) Q1 FY23, the Company depicted a revenue Compound Annual Growth Rate (“CAGR”) of 3.2% and operating income CAGR of -1.5%, reaching a TTM revenue of c. $21B and operating income of $2.4B (margin of 11.6%). Carrier has cash and cash equivalents of $3.3B compared to total debt and lease liabilities of $9.4B.
Price & Market Cap (as of 24th May 2023): Its market cap is $34.5 billion with a 52-week low of $33.1 and a 52-week high of $49.2, whereas it currently trades at $41.3.
Valuation: Carrier trades at a TTM EV/EBITDA of 14.6 (3 Year average of 16) and a TTM EV/Sales of 2 (3 Year average of 2.2).
The rest of the write-up includes the following sections:
2. Business Overview
3. Management
4. Industry
5. Financial Analysis
6. Competitive Advantages, Opportunities and Risks
7. Valuation
8. Conclusion
2. Business Overview
Carrier, with its rich 100-year history, has established itself as a global leader in the HVAC and refrigerator manufacturing business. As the industry undergoes significant transformations driven by mega-trends like electrification and renewable energy, Carrier's position and ongoing restructuring efforts make it an intriguing player.
A New Era for Carrier
In April 2020, Carrier was spun off from United Technologies ("UTC") and emerged as an independent publicly traded company. UTC's decision to separate Carrier, as well as Otis (Elevator Company) into distinct entities was driven by the belief that this would serve the best interests of UTC's shareholders and the businesses involved. This approach aligns with the idea that, in many cases, the value of individual businesses can be greater than the combined value of the conglomerate.
The board of directors at UTC cited several reasons for the spin-off, including:
Enabling Carrier to focus on its core business allowing for improved growth and profitability,
The separation provides Carrier's management team with greater agility to capitalize on industry trends,
It allows Carrier to pursue its own capital structure and allocate resources as it deems fit, without competing for financial resources within UTC.
With $11 billion of debt after the spinoff and $590 million in cash, Carrier embarked its journey as a new publicly traded Company prioritizing investments on its core segments, such as HVAC, refrigeration, and building automation.
Segments
Carrier operates through three main segments: HVAC, Refrigeration, and Fire & Security. In FY 22, these segments accounted for approximately 64%, 19%, and 17% of the Company's revenue (excluding inter-segment eliminations), respectively. This represents a change from the 2019 revenue mix, where HVAC accounted for 50%, Refrigeration for 21%, and Fire & Security for 29%.
Source: Stratosphere.io, StockOpine Analysis
The increase in the HVAC segment's contribution primarily stems from higher organic growth (6.8% CAGR from FY17 to FY22) and the acquisition of Toshiba Carrier Corporation (TCC) in 2022. Conversely, the decline in the Fire & Security segment is attributed to lower organic growth (0.4% CAGR during the same period) and the divestment of Chubb Fire & Security Business (“Chubb”) in 2021. Furthermore, in Q1'23, Carrier announced its intention to exit the Fire & Security business to further concentrate on its HVAC/R business.
“The result will be a new Carrier with higher revenue and EBITDA growth profiles, leading market positions globally with a portfolio unlike any other company in the world.” David Gitlin, CEO
In terms of geographic revenue distribution, Carrier generates 60% of its sales from the Americas, 23% from Europe, Middle East, and Africa (EMEA), and 17% from the Asia Pacific region. This reflects a change from FY 19, where the Americas accounted for 55%, EMEA for 30%, and Asia Pacific for 15% of revenue.
Regarding revenue sources, new equipment sales contributed 77% to the company's revenue in FY 22, while parts and services (aftermarket) accounted for the remaining 23%. This compares to a split of 72% and 28% in FY19, respectively.
Management’s target is to grow aftermarket sales to $7+ billion by 2026, implying a CAGR of approximately 9% and compares to historical low single-digit level growth prior the spin off. It shall be noted that Patrick Goris, CFO, recently indicated that their aftermarket business (c. $5B) only covers 20%-25% of the available revenue of its installed base and that expanding on this front is a key priority. Additionally, aftermarket sales have higher margins (+10%) thus any expansion will be margin accretive.
HVAC Segment
This segment provides a wide range of products and services for both residential and commercial customers. Notable offerings include air conditioners, heating systems, heat pumps, controls, and aftermarket components. Carrier's portfolio encompasses renowned brands such as Carrier, Toshiba, Bryant, and Automated Logic, further establishing its market presence in the HVAC industry.
Source: Carrier 10-K Reports, StockOpine Analysis
The HVAC segment of Carrier has exhibited significant revenue growth in 2021, driven by a 17% organic growth fueled by favorable market conditions such as increase new construction, stay-at-home trends, higher distributor stocking levels, and pricing improvements.
In 2022, the HVAC segment grew 18%, with organic growth of 12% primarily attributed to price improvements rather than volumes. The remainder was driven by the consolidation of TCC results. Moving into Q1’23, HVAC segment seems to hold strong with organic growth of 6%, orders up 5% and backlog up by double digits year-over-year with the driving factor being commercial HVAC and aftermarket sales.
The HVAC segment underwent significant changes in recent years as part of its strategic focus on its core businesses, resulting in notable impacts on profitability. The most notable changes include:
In 2017, the sale of the investment in Watsco Inc (HVAC distributor) which resulted in a gain of approximately $380 million. If you are interested to read more about Watsco Inc, here is our write-up released in April.
In 2020, the sale of the investment in Beijer Ref (HVAC distributor) generated a gain of approximately $1.1 billion.
In 2022, the acquisition of control in TCC which led to the recognition of a fair value gain of $705 million.
These transactions had varying effects on the financial performance of the HVAC segment, contributing to changes in profitability over the years. Excluding non-recurring gains and losses, HVAC adjusted operating profit margin averaged at a rate of 15.8% from FY19 to FY22 with FY22 adjusted margin standing at 15.2%. The lower adjusted operating margin in FY22 compared to adjusted operating margin of 15.7% in FY21 is mainly due to the acquisition of TCC which had 70 bps dilutive impact.
TCC, a variable refrigerant flow ("VRF") and light commercial HVAC business, was previously operated as a joint venture between Carrier and Toshiba, with ownership stakes of 40% and 60% respectively. In August 2022, Carrier acquired an additional 55% ownership for $930 million, increasing its total ownership to 95%. Since the acquisition, TCC has contributed approximately $800 million in sales.
Considering an estimated annual sales of $1.9 billion, Carrier's acquisition of TCC implies a price-to-sales multiple of approximately 0.9x. When compared to Carrier's average Price/Sales multiple of 1.9x, it appears that the Company did not overpay for the acquisition.
Refrigeration
The Refrigeration segment offers transport refrigeration equipment and monitoring systems for trucks/trailers and shipping containers as well as commercial refrigeration products. Transport refrigeration products are used for the management and monitoring of temperature-controlled environments necessary for the transport and preservation of food, medicine and other perishable cargo. Commercial refrigeration equipment includes refrigerated cabinets and freezers.
Along with the announcement in Q1’23 of the intention to exit Fire & Security business, the Company also announced its plans to exit its Commercial refrigeration business. The divested part approximates to $1.1B sales or ~28% of Refrigeration segment and will be margin accretive as it had an adjusted EBITDA margin at the high single digit levels (lower than the average).
Source: Carrier 10-K Reports, StockOpine Analysis
During FY17 to FY22 the refrigeration segment grew at a CAGR of 0.4% while organic growth stood at 2.8%. The spike in revenue observed in FY21 was mainly driven by transport refrigeration which grew by 28% as a result of global supply chain improvement and Covid-19 vaccine monitoring. The significant increase in operating margin observed in FY18 can be attributed to the divestment of the foodservice equipment business, Taylor, for $1 billion, resulting in a gain of $799 million. Using adjusted operating margin, the refrigeration segment's profitability averaged 12.5% from FY19 to FY22, with FY22 standing at 12.4%.
Fire & Security
The Fire & Security segment provides residential, commercial and industrial technologies for property and fire protection. The segment provides installation and maintenance services for products such as fire, intruder alarms, access control systems and video management systems.
Source: Carrier 10-K Reports, StockOpine Analysis
The Fire & Security segment has experienced relatively flat organic growth with a CAGR of 0.4% over the period under review. However, in FY22, there was a significant decline in revenue due to the sale of Chubb for $2.9B, resulting to a gain of $1.1B. Chubb generated $2.2B in sales in FY21.
When excluding the impact of the Chubb sale in FY22, the segment's adjusted operating profit averaged at 13.7% over the period, with FY22 adjusted margin standing at 15.2%. It is evident that the Chubb business had lower margins compared to the rest of the segment. Management successfully sold Chubb at a 13x EBITDA multiple and expects to sell the remaining businesses at even higher multiples due to their superior profitability. It is worth noting, that the planned divestment is likely to be margin neutral to the Company as it had a similar EBITDA margin with the HVAC segment in FY22.
Acquisition of Viessmann Climate Solutions
Carrier has recently announced the acquisition of the German and privately held ‘Viessmann Climate Solutions’ (“Viessmann”), for a cash and stock transaction valued at €12 billion ($13.2 Billion). Viessmann is a market leader in Europe’s premium residential segment, and the deal is set to be finalized by the end of the year subject to customary closing conditions and regulatory approvals.
The 106-year-old German company is a leader in premier heat pumps, with about 40% of its sales originating from Germany, in addition to strong positions in France, Poland and Italy. The combination of these four countries accounts for more than 50% of the heat pumps installed in Europe, with 20% annual heat pump growth rate.
This is a strategic move by Carrier as it plans to further expand into Europe by creating a “global climate champion” by acquiring Viessmann said David Gitlin, Chairman & CEO. “It positions our portfolio to expand into integrated renewable offerings in a unique and differentiated way”.
Heat pump’s sales have not only increased dramatically over the past two years, but they are a key component of a greener future. McKinsey & Company reports that a worldwide replacement of traditional boilers and furnaces could cut global CO2 emissions by 3 gigatons per year which approximates to 8.2% of global energy-related CO2 emissions in 2022.
According to McKinsey & Company “heat pumps could constitute approximately 90 percent of new heating unit sales by 2050, compared with 35 percent today” and Carrier is already benefitting from this trend. Furthermore, European governments are taking actions to promote renewable and electric solutions for heating and cooling which is expected to triple the European heat pump segment (in which Viessmann specializes) from $5 billion to $15 billion by 2027.
With €4 Billion expected revenue for 2023, the Next Twelve Months (“NTM”) EV/Sales ratio is 3x which is higher than industry averages (graph below), indicating signs of