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Air Conditioner & Heating Industry Outlook Grim

Shrabana Mukherjee

The Zacks Building Products - Air Conditioner & Heating industry comprises designers, manufacturers and marketers of a broad range of products for the 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 is sold to residential replacement, commercial and industrial HVAC (Heating, Ventilation and Air Conditioning), and residential new construction markets.

Let’s take a look at the industry’s three major themes:

  • The residential construction market slowdown in the United States has made the operating backdrop a bit difficult for the industry players. Meanwhile, rising raw material costs due to tariffs and trade restrictions have been hurting profit margins to some extent. Also, rising freight expenses, stiff competition and the impact of seasonality on the industry’s revenues pose significant risks to the forthcoming quarters. The industry is also susceptible to heavy governmental regulation on energy efficiency and gas emission. HVAC systems use refrigerant for cooling that is harmful to humans and the environment.
     
  • Though the U.S. housing market slowdown has been creating pressure on the industry participants, spurred up demand courtesy of a rise in disposable and per capita income, lower unemployment rate, and improving consumer confidence, cannot be ignored. Higher construction spending activity in non-residential, commercial and industrial sectors is a boon to the Air Conditioner & Heating industry, boosting companies’ revenues and profits.
     
  • Along with accelerated construction spending in the United States, continued investments in technologies designed to revolutionize customer-experience seem to be vital growth catalysts to 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 momentum. Importantly, new investments in the expansion of distribution footprint, research and development projects as well as marketing programs are contributing significantly to the companies’ top lines. The companies are also actively pursuing accretive acquisitions to broaden their product portfolio and expand geographic footprint as well as market share. Meanwhile, services associated with maintaining, monitoring and repairing existing equipment are also providing the industry participants a stable source of revenues. Notably, the industry generates a major share of its revenues from these services, which consumers generally cannot suspend even when the construction markets fluctuate.

Zacks Industry Rank Indicates Dull Outlook

The Zacks Building Products - Air Conditioner & Heating industry is a five-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #219, which places it at the bottom 14% 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 dismal near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms 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 negative 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 Jan 31, 2019, the industry’s earnings estimate for the current year has gone down 2.2%.

Despite the dull scenario, we will present a few stocks that can be bought or retained, considering their robust growth endeavors. Prior to that, let’s take a look at the industry’s shareholder returns and current valuation.

Industry Outperforms S&P 500 and Sector

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

The industry has gained 11.6% over this period compared with the S&P 500’s increase of 6.7%. The broader sector has declined 5.4% in the said time frame.

One-Year Price Performance


 
 Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings ratio, which is a commonly used multiple for valuing Air Conditioner and Heating stocks, the industry is currently trading at 24.1X versus the S&P 500’s 17X and the sector’s 14X.

Over the past five years, the industry has traded as high as 27.6X, as low as 13.5X and at the median of 23.2X, as the chart below shows.

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

 

Bottom Line

A major boost in infrastructural and construction spending should continue to favor the industry’s performance. Additionally, maintaining, monitoring and repairing services along with prudent cost-management practices leveraging technology should lend support. However, the aforementioned growth factors seem to be weighed down by headwinds arising from rising costs, heavy governmental regulation and competitive pressure.

None of the stocks in this Zacks universe currently carry a Zacks Rank #1 (Strong Buy) or 2 (Buy). Nonetheless, investors may hold on to the following three stocks, which currently carry a Zacks Rank #3 (Hold) and have solid earnings growth prospects. You can see the complete list of today’s Zacks #1 Rank stocks here.

Lennox International Inc. (LII): This Richardson, TX-based provider of climate control solutions on an international scale has an expected earnings growth of 30.7% for 2019.

Price and Consensus: LII



Comfort Systems USA, Inc. (FIX): The Houston, TX-based leading provider of mechanical services — including heating, ventilation, air conditioning, plumbing, piping and controls — has an expected earnings growth of 11.3% for 2019.

Price and Consensus: FIX



Watsco, Inc. (WSO): Headquartered in Miami, FL, Watsco distributes air conditioning, heating, and refrigeration equipment; and related parts in the United States, Canada, Mexico and Puerto Rico. It has a three-five year expected earnings growth rate of 12.5%.

Price and Consensus: WSO



Below are two stocks with a bearish Zacks Rank that we would recommend investors to stay away from for the time being.

Tecogen Inc. (TGEN): Headquartered in Waltham, MA, this company designs, manufactures and sells industrial and commercial cogeneration systems that produce combinations of electricity, hot water and air conditioning. This stock carries a Zacks Rank #4 (Sell) and the consensus earnings per share estimate has moved to a loss of 13 cents per share from an earnings of 3 cents for the current year, over the last 60 days.

Price and Consensus: TGEN



AAON, Inc. (AAON): This Tulsa, OK-based manufacturer of air-conditioning and heating equipment carries a Zacks Rank #4. The consensus earnings per share estimate has moved 2.3% south for the current year, over the last 60 days.

Price and Consensus: AAON




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