CARR – Carrier Global: Another Buying Opportunity Has Presented Itself

Summary

Carrier Global (NYSE:CARR) should continue to benefit from the long-term secular tailwinds in the HVAC market. In the short-term, growth will see tailwind from the replacement cycle, particularly in the residential sector, as summers are getting hotter and winters are getting shorter, which increases the likelihood of breakdowns and necessitates emergency replacements. The share price has moved in the direction I expected previously, until the latest earnings which has complicated things. Especially the Viessmann deal which I think is strategically accretive, but the market seems to not give CARR the benefit of doubt (given how the share price has moved). I believe the stock is still undervalued, and management is moving the business (through M&A and reorg) in the right direction. I reiterate my buy rating.

Viessmann acquisition

Let’s address the most pressing issue first: the Viessmann acquisition. The terms of the deal call for EUR12 billion to be paid by CARR, with cash accounting for 80% and stock for the remaining 20%. The purchase price implies a multiple of 17.1x FY23 EBITDA. In my opinion, this transaction significantly strengthens CARR’s strategic position in the European residential HVAC market, with a particular emphasis on heat pumps. From a financial synergies standpoint, I believe there is nothing to dislike given Viessmann is expected to grow at 10% CAGR for the next several years – which I note is higher than CARR consolidated growth rate. CARR will also extract about €200 million in cost synergies, most of which are driven by the supply chain, so I think it’s safe to assume that this goal will be easily met. The transaction multiple might seem high from the headline, but after adjusting for the EUR200 million cost synergies, the multiple comes down to around 13x. Since CARR is forking over a higher multiple than it generates on its own, some investors may view this as pricey. However, I believe the post-synergy multiple is alright given Viessmann is expected to grow faster than CARR and it has proven track record of high, sustained growth. Since 2020, Viessmann’s sales and EBITDA have grown at a CAGR of more than 15%, and continued double-digit expansion is expected through 2023. Importantly, Viessmann’s portfolio includes smart home controls and applications, as well as renewable energy capabilities and home battery storage, which are all complementary to CARR’s portfolio, and CARR management intends to scale this internationally. I expect revenue synergies here as well, which I think management is not being vocal about yet. In addition to the portfolio synergies, Viessmann will allow CARR to enter the lucrative European residential market, where 80-90% of the business is replacement work, as noted by management. By leveraging on Viessmann well-established distribution system across Europe thanks to its premium brand, unified digital platform, and network of 75,000 installer partners, I expect CARR to efficiently capture the Europe demand.

Reorg

While the big corporate action is ongoing, CARR is also getting a lot of attention for its Fire & Security [F&S] and Commercial Refrigeration business (planned for divesture). From the details provided during the 2023 Goldman Sachs Industrials and Materials Conference, Commercial Refrigeration will be a divestment but there are other plans for F&S. Unlike the Commercial Refrigeration, I believe management should maximise the sale of F&S to further optimize the business cost structure. Management has stated that they are open to the possibility of spinning off CARR, selling F&S separately, or selling both F&S and Security separately. In my opinion, the sale and divesture of these 2 segments is positive as it allows CARR to drive towards the direction of being a company that focuses on HVAC and other intelligent climate/energy solutions.

Valuation update

Among all of these corporate action movements, I believe another buying opportunity has presented itself. While I agree that some investors are correct to sell the stock given the uncertainty surrounding the Viessmann acquisition, I believe fortune favors the brave in this case. The acquisition has strong strategic value in my opinion, and I hope it closes successfully. Previously when I wrote about CARR, the stock was trading at 17x forward earnings without the prospect of Viessmann. Today, the stock is trading at 15x forward earnings. I believe the multiple today is a lot cheaper than when it was at 17x, relatively to growth and market position. Given its streamlined portfolio following the sales, divestiture, and acquisition, CARR, in my opinion, deserves to trade at a structurally higher multiple than in the past. As a result, I believe the stock return will be driven by a re-rate in multiples back to at least its historical average of 18x. Based on this, I expect the stock to return 40%. The successful completion of the current corporate actions would be the catalyst.

Risks

The failure to acquire Viessmann due to any potential obstacles (most likely regulatory, if it happens) would be a risk that would push the stock even lower. If this occurs, the group of investors who are incorporating the Viessmann growth prospect into CARR will most likely sell the stock, and the group of investors who sold during this period (avoiding the acquisition) will be unlikely to return to the stock because the narrative surrounding the stock will be negative. Consensus estimates that have been revised will almost certainly be revised again, adding to the stock’s negative sentiment.

Conclusion

In conclusion, CARR is poised to benefit from long-term growth in the HVAC market, driven by secular tailwinds and the increasing need for replacements in the residential sector. As for the Viessmann acquisition, I believe it strategically strengthens CARR’s position in the European market, with financial synergies and growth prospects that justify the purchase price. Furthermore, the reorganization plans, including the divestment of Commercial Refrigeration and potential sell-off of the Fire & Security segment, will enable CARR to focus on its core HVAC business and intelligent climate/energy solutions. From a valuation perspective, CARR stock currently presents a buying opportunity, trading at a lower multiple than before.