Summary
Carrier has done great since being spun off from UTC.
The operating performance has been resilient, as expectations of investors have only been on the increase.
This re-rating has been largely warranted, yet I think that it has been a bit too much here.
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bymuratdeniz/E+ via Getty Images Carrier (NYSE: CARR ) is a company which has been on fire since the company has been spun off from its former parent company UTC. In July 2020 I believed it was time for shares of Carrier to cool off, after the shares rallied 75% in a very short period of time, which made that I took profits, and with the benefit of hindsight this has been far too early.
The re-rating has continued and actually turned into a premium valuation, which I can explain because of solid execution, but the current premium attached to the shares seems a bit of an exaggeration here. Former Take
Carrier is essentially a mini conglomerate, which once was part of United Technologies, focusing on HVAC, refrigeration and fire and security, being positioned to benefit from some long-term secular trends. While the business was spun off, the company itself is very large as it generated $18.6 billion in revenues in 2019, on which very nice operating profits of $2.6 billion were reported, for margins equal to 14%.
The HVAC business, for which the business is best known, generated roughly $10 billion in sales, with fire and security generating over $5 billion in revenues and the refrigeration segment generating nearly $4 billion in revenues. The company is quite well diversified from a geographical point of view, as sales are split between upfront equipment purchases and service and aftermarket segments.
Net debt of $10.3 billion was a bit high at the time of the spin-off, with EBITDA seen around $2.9-$3.2 billion, resulting in a 3.2-3.5 times leverage ratio. Working with an operating profit number of $2.6-$2.9 billion and applying a 4.5% cost of debt and 20% tax rate, I believed that earnings could top $2 per share based on 866 million shares outstanding. With the company trading at just $14 at the time of the spin-off, I was very upbeat on the shares, despite the leverage and uncertainty relating to the pandemic.
What happened is that within three months of initiating that position, shares rallied 75% to $25, as valuations were still reasonable, but not as dirt cheap anymore. Given this huge move higher, I took profits. This decision was furthermore driven by first quarter sales falling 10% as the 2020 outlook, calling for sales at a midpoint of $16 billion and operating earnings at $1.7-$2.0 billion, was not too pretty either. This increase in leverage, higher forward multiples, and the increase in leverage and lower earnings power made that I was happy to take the profits. What Happened?
Since that point in time, shares have been doing well, in part as the role of HVAC could be interesting, potentially tackling the spreading of the pandemic by increasing air quality and ventilation in buildings.
Second quarter sales fell 20% amidst the height of the pandemic as the company more or less maintained the full-year guidance. The third quarter results were particularly strong with quarterly sales up 4% on an annual basis to $5 billion as the company convincingly raised the full year guidance, both on the sales and margins fronts. Towards the end of the year, the company further deleveraged by selling its remaining stake in Beijer Ref AB, raising another $300 million while still carrying a stake in the business.
In February 2021 the company posted its 2020 results, with shares trading at $37 at the time. Full-year sales were down 6% to $17.5 billion, as adjusted operating profits fell 19% to $2.2 billion, but arguably the second half of the year has been much stronger. The company posted adjusted earnings of $1.66 per share, down from my $2 per share target on the back of the pandemic and the fact that lower refinancing costs do not immediately come through. Comforting was the 2021 outlook, calling for organic sales to increase in the mid single digits, with adjusted earnings seen at a midpoint of $1.90 per share.
Net debt has been cut to $7.1 billion and with adjusted EBITDA trending at $2.6 billion in a downbeat year, leverage was not a major concern anymore. Nonetheless, expectations were higher at $37, with shares […]
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