Air conditioning is heating up, according to Wall Street analysts.
Bank of America Merrill Lynch analyst Andrew Obin upgraded shares of Ingersoll-Rand (ticker: IR) to Buy from Neutral, saying the stock can rise to $130. That’s 16% above recent levels.
And Morgan Stanley analyst Josh Pokrzywinski wrote that consolidation in the heating, ventilation and air-conditioning is at a “now or never moment.” Pokrzywinski prefers United Technologies (UTX) stock as a result.
If those two Thursday calls are correct, HVAC stocks could be a way to make money by investing in industry even as the economy slows.
The back story. Historically, HVAC has been a more stable corner of industry than areas such as heavy machinery. HVAC demand doesn’t depend on capital budgets, which often get cut when the economy slows. Repairs and replacements account for the bulk of sales, so new construction isn’t critical. No one wants to live without air conditioning.
Those favorable industry economics are one reason Lennox International (LII), trades at a higher valuation multiple than other industrial stocks. Lennox is focused exclusively on U.S. residential air conditioning and its stock is trading for 21.7 times estimated 2019 earnings. That’s the same as its historical average and a 25% premium to industrial peers.
Other HVAC businesses are embedded in industrial conglomerates. Johnson Controls International (JCI), United Technologies, and Ingersoll-Rand sell air-conditioning parts and services to residential and commercial customers. The three historically have traded at the same valuation multiples as other industrial stocks, for about 17 times estimated earnings.
The industry is changing because United Technologies is splitting into three companies: an elevator maker, an aerospace company, and an HVAC company called Carrier. United Tech’s transformation will be completed in about a year and while the transactions unfold, HVAC consolidation will be a hot topic for Wall Street analysts.
What’s new. Pokrzywinski believes a combination of United Technologies’ Carrier division and Lennox International could pass muster with antitrust authorities. He even put a date on his prediction, saying deal news could come this quarter. That’s a bold call, but he thinks United Technologies CEO Greg Hayes has been publicly hinting at a transaction by talking about valuation parameters and deal structure.
The companies declined to comment.
In his note raising his rating on Ingersoll, Obin said persistently low interest rates could boost U.S. housing demand in 2019. That would benefit Ingersoll’s HVAC business—as well as the air-conditioning businesses of the other three players.
Looking ahead: Buying industrial stocks as the economy slows down may not seem like a good idea. Manufacturing is under pressure in Germany and China, two of the largest industrial economies in the world. That means investors should be more selective about what to buy in the industrial space. HVAC seems to be a safe bet.
Barron’s recommended Lennox and Ingersoll-Rand stock in November. Since then Lennox shares have risen 26% and Ingersoll shares are up 13%. The Dow Jones Industrial Average is up 3.5% over the same span.
The biggest danger for Lennox stock looks to us like the risk of no deal happening. Lennox stock is trading in line with its historical average, but if deal fervor fades, we could see the stock give back some of its recent outperformance.