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2 Air Conditioner & Heating Stocks From a Challenging Industry

Housing market slowdown, supply-chain disruptions and inflationary pressures have been creating hurdles for the Zacks Building Products - Air Conditioner & Heating industry. That said, industry players like Lennox International Inc. LII and AAON, Inc. AAON have been benefiting from maintenance, monitoring and repairing services along with prudent cost-management practices. Also, the replacement of older systems to reduce electricity consumption and carbon footprint, as well as planned investments in technologies to capture more growth, is acting as a major tailwind for the industry participants.

Industry Description

The Zacks Building Products - Air Conditioner & Heating industry comprises designers, manufacturers, and marketers of a broad range of products for heating, ventilation, air conditioning, and refrigeration markets. The products include rooftop units, chillers, air-handling units, condensing units and coils. The industry players also supply thermostats, insulation materials, refrigerants, grills, registers, sheet metal, tools, concrete pads, tape and adhesives. Air conditioning and heating equipment are sold in residential replacement, commercial and industrial HVAC (heating, ventilation and air conditioning) as well as residential new construction markets.

3 Trends Shaping the Future of the Air Conditioner & Heating Industry

Housing Market Slowdown, Supply-Chain Woes, Rising Costs, Regulations: The recent slowdown in the U.S. housing market has been impacting the demand for industry players’ products. Presently, the outlook for the housing industry remains less favorable compared to the last couple of years due to several ongoing headwinds, such as a rapid increase in mortgage rates, housing affordability challenges, high inflation and growing concerns about the economy.

Meanwhile, supply-chain disruptions and rising raw material costs have been hurting the profit margins of industry participants. Supply-chain constraints remain a key issue, resulting in inefficiencies and larger inventory. Operating expenses of companies are rising, thanks to pandemic-related business challenges and sharp rises in variable operating expenses, including company-wide, performance-based compensation, excessive logistics and freight costs. Meanwhile, the industry is also susceptible to stringent governmental regulations on energy efficiency and gas emissions. HVAC systems use refrigerants for cooling, which is harmful to humans and the environment. Also, stiff competition and the impact of seasonality on the industry’s revenues are significant risks.

U.S. Administration’s Pro-Environmental Moves: Reducing greenhouse gas emissions for a cleaner environmental footprint has been a major focus of the U.S. administration. Many industry participants remain engaged in supporting industries and facilities by selling and maintaining clean and efficient energy systems to reach their environmental goals for carbon reduction while providing resiliency to grid outages. The companies are gaining from the fast-growing controlled environment agriculture industry, courtesy of their consistent supply of clean cooling solutions. Overall, the companies are well positioned to gain from the renewable energy drive of the pro-environmental U.S. administration. Meanwhile, the companies have also been benefiting from an improvement in the non-residential market along with a rise in repair and remodeling activities.

Technology Augmentation & Inorganic Moves: Persistent investments in technologies designed to revolutionize customer experience seem vital for the industry. Digitization of the companies’ marketplace via e-commerce and iOS/Android-enabled apps, supported by a comprehensive database of product information, continues to see strong momentum. Importantly, new investments in the expansion of distribution, research and development projects, and marketing programs are contributing significantly to the companies’ top lines. The players are also actively pursuing accretive acquisitions to broaden their product portfolio and expand their geographic footprint as well as market share. Meanwhile, services associated with maintaining, monitoring and repairing the existing equipment are also providing industry participants with stable revenue sources. The industry generates a major share of revenues from these services, which consumers generally cannot suspend even when the construction market fluctuates.

Zacks Industry Rank Indicates Dull Prospects

The Zacks Building Products - Air Conditioner & Heating industry is a six-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #178, which places it in the bottom 29% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of the bleak earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since October 2022, the industry’s earnings estimates for 2023 have decreased to $4.73 per share from $4.91.

Despite the industry’s blurred near-term view, we will present a few stocks that one may consider adding to their portfolio. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Outperforms S&P 500, Sector

The Zacks Air Conditioner & Heating industry has outperformed the broader Zacks Construction sector and Zacks S&P 500 composite over the past year.

Over this period, the industry has gained 20% compared with the broader sector’s 3.5% rise. Meanwhile, the Zacks S&P 500 composite has slipped 6.8% during the period.

One-Year Price Performance

Industry's Current Valuation

On the basis of the forward 12-month price to earnings, which is a commonly used multiple for valuing Air Conditioner and Heating stocks, the industry is currently trading at 27.6X versus the S&P 500’s 18.4X and the sector’s 15.4X.

Over the past five years, the industry has traded as high as 39.9X, as low as 19.4X and at a median of 24.3X, as the chart below shows.

Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500

2 Air Conditioner and Heating Stocks to Keep a Close Eye On

Below, we have discussed two stocks from the Zacks Air Conditioner & Heating universe that have solid growth potential. The chosen companies currently carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

AAON, Inc.: Based in Tulsa, OK, AAON engineers, manufactures and markets air conditioning as well as heating equipment. The company maintains a balance between new construction and replacement applications and is making the most of robust replacement demand, broadly across the non-residential building market. Despite inflationary cost pressure, the BasX acquisition, which was closed in December 2021, has been delivering solid results for AAON. While supply-chain issues and inflation caused similar issues, BasX has been flexible in adapting to challenges.

AAON has gained 39% over the past year. Earnings are expected to grow 50% in 2023.

Price and Consensus: AAON

Lennox: This Richardson, TX-based company provides energy-efficient climate-control solutions. Growth across all three segments (Residential, Commercial and Refrigeration) and solid execution on Commercial business profit recovery have been driving Lennox. The company has been implementing higher pricing to outpace the ongoing inflationary challenges.

Lennox has gained 7% over the past year. The company is expected to witness 5.5% earnings growth in 2023.

Price and Consensus: LII

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