Carrier Global Corporation (NYSE:CARR) has outperformed the S&P 500 (SPY) since our last bullish article and is trading near its 52-week highs. Looking forward, the company is well-positioned for near-term growth due to price increases, a strong backlog, and benefit from the TCC acquisition. In the long term, the company is expected to benefit from favorable regulations related to energy efficiency and sustainability, as well as a growing middle-class population.
On the margin front, I am expecting flattish year-over-year performance in FY23, with benefits from price increases and productivity savings likely to be offset by technology investments and the inclusion of lower-margin TCC acquisition. In the longer term, margins should improve with input cost reduction, a better mix from increasing aftermarket sales which carries higher margins, and the realization of cost synergy from the TCC acquisition.
The company’s current valuation is lower than its historical average. Additionally, management’s efforts towards deleveraging the balance sheet should help re-rate the valuation multiple higher. Given good growth prospects and a reasonable valuation, I have a buy rating on CARR stock and believe it can continue its outperformance.
Revenue Analysis and Outlook
Following the pandemic, Carrier Global Corporation experienced robust demand in its HVAC segment, driven by strong demand in residential and light commercial businesses, as well as improved global end markets in the commercial HVAC business. The Refrigeration and Fire & Security segments also witnessed positive growth due to improved global end markets.
In the fourth quarter of 2022, CARR’s HVAC segment continued to experience growth momentum. However, the Refrigeration and Fire & Security segments experienced a decline in revenue. The HVAC segment reported a YoY revenue growth of 21.5%, driven by strong performance in the Light Commercial and Commercial businesses, as well as the inclusion of the Toshiba Carrier Corporation (TCC) acquisition, partially offset by weak demand in the Residential business. The Refrigeration segment reported a YoY decline of 13.5% in revenue due to significant currency translation headwinds and weak demand from Commercial Refrigeration and Container businesses, partially offset by strength in the Truck and Trailer business. The Fire & Security segment witnessed a YoY decline of 32.9% in revenue, primarily due to the divestiture of Chubb’s business, which accounted for 36 percentage points YoY decline in revenue. On an organic basis, the segment revenue grew by 6%, primarily driven by price increases. Overall, the company reported 5% organic sales growth driven by an 8% increase in prices, while volume declined a couple of percentage points.
Looking ahead, CARR is expected to continue benefiting from price increases and a strong backlog in the near term. In the past 18 months, the company has raised prices multiple times to keep up with inflation, which has benefitted its revenue growth. According to management, the carryover impact of price increases in the back half of last year and recent hikes are expected to add around $600 million to revenue in 2023. The company’s backlog is also at an elevated level, almost double that of 2019 or pre-Covid levels. As supply chain constraints ease, the backlog is expected to be converted into revenue at a faster pace, supporting revenue growth in the coming quarters.
Aside from pricing and backlog-related benefits, the company’s revenue should also benefit from the TCC acquisition, which was completed in July last year.
In the long run, the company’s revenue growth is expected to benefit from regulatory tailwinds and secular demand drivers. The trend towards energy efficiency and sustainability has led to regulatory tailwinds such as the recently enacted SEER2 framework and upcoming changes in refrigerant standards in 2025. The Inflation Reduction Act is also expected to benefit the industry in the coming years. Additionally, the growing middle-class population and the resulting need for refrigeration and HVAC are expected to support long-term demand for CARR.
Furthermore, the company is expected to increase M&A activity in the future, given its strong cash-generating businesses and improving balance sheet. The company has reduced its debt meaningfully post the spin-off from United Technologies. As of the last quarter’s end, the company’s net debt was $5.3 billion vs $9.9 billion in April 2020 (at the time of its spin-off.) The improved balance sheet can be used for M&As to enhance the company’s digital capabilities, grow aftermarket business, expand into adjacencies, or increase geographic coverage. The recent acquisition of TCC is an example of this, and management is likely to consider similar M&As in the future.
Overall, CARR’s revenue is poised to grow in the near term due to price increases, a healthy backlog, and the benefit from the TCC acquisition. In the long term, the company is expected to benefit from favorable regulations and growing demand. The company’s improving balance sheet should further enhance its ability to do M&A, leading to even more growth opportunities.
After separating from United Technologies, CARR has improved its adjusted operating margin over the last couple of years by implementing productivity initiatives and price hikes which more than offset input cost inflation. In 2022, the company reported a year-over-year 50 basis point adjusted operating margin improvement.
Looking ahead, CARR is expected to benefit from continued pricing and productivity initiatives that should help margins. However, in FY23 input cost inflation, technology investments, and the inclusion of the lower-margin TCC business are expected to offset this benefit.
Management anticipates $300 million in gross productivity savings for 2023 from supply chain optimization, automation, G&A reduction, and footprint optimization. Of this amount, they have earmarked $200 million for investments in aftermarket enabling technologies. The company is also expected to incur ~$100 million in costs related to the integration of the TCC acquisition and other minor expenses. So, the benefit from productivity savings should be offset by technology investment and costs related to TCC integration. The company is also expected to benefit from price increases and should see a $200 million increase in operating profit from positive price/cost. However, operating margins are expected to remain nearly flat in FY23 due to the inclusion of the lower-margin TCC business.
In the longer term, CARR’s margins are expected to benefit from productivity savings and synergy opportunities from the TCC acquisition. Management is also focusing on growing higher margin aftermarket business, which should improve the mix. Hence, I am optimistic about longer-term margin prospects.
Currently, the stock is trading at a P/E of ~17.98x for the FY23 consensus EPS estimate of $2.57, which is lower than its historical average forward P/E of 19.94x. Given CARR’s good near and long-term growth prospects as well as lower than historical valuations, I find the stock attractive. Additionally, the company is deleveraging and has significantly reduced its net debt over the last couple of years. This can help re-rate CARR’s PE multiple higher. Given good growth prospects and a reasonable valuation, I have a buy rating on the stock.