CARR - Carrier Global: Carrying Great Momentum Into 2024

2024-01-09 17:43:56 ET

Summary

• Carrier Global Corporation has proven to be a solid value creator since its spinoff from United Technologies.
• The company's recent divestments and strong momentum create reasons to be optimistic about its future prospects.
• The acquisition of Viessmann Climate Solutions and other strategic moves position Carrier for growth, but valuations have re-rated and there is uncertainty about the outlook for 2024.

In April of last year, I believed that Carrier Global Corporation ( CARR ) was getting a bit carried away as it acquired Viessmann Climate Solutions from the Viessmann Group. Since its successful spinoff from United Technologies, the company has quickly proven to be a solid value creator, as it made a big move into Germany. Despite the solid strategic rationale, the deal came at a price, so I was waiting for a better entry point.

Strong momentum in recent quarters, and Carrier delivering on promised divestments at more than fair prices, create reasons to be upbeat, as the business looks well positioned going forward, although priced as such to a great extent as well.

On Carrier

Carries is essentially a mini conglomerate that focuses on HVAC, refrigeration and fire & security - or at least it was active in all these markets until recent. Despite previously being just a part of United Technologies (now part of RTX Corporation), after which it was spun off as a separate business in 2020, the company has a formidable size.

For the year 2019, ahead of the spinoff, the company generated $18.6 billion sales and operating profits of $2.6 billion, for margins equal to 14%. Most of these sales were derived from a $10 billion HVAC business, with the other activities roughly equally responsible for the remainder of sales. The business furthermore had a decent split between geographies and upfront equipment and aftermarket services.

A net debt load of $10 billion at the time worked down to a leverage ratio in excess of 3 times, while earnings came in around $2 per share. With shares trading at a mere $14 per share at the time of the spinoff, valuations were quite interesting.

Since the spinoff, the company quickly recovered from the pandemic, and in 2021 it announced a big sale, selling the Chubb fire and security business in a $3.1 billion deal, which involved lower-margin activities and $2 billion in sales leaving the door. At the time a $50 stock already, the re-rating was more than complete as earnings power had just modestly risen above $2 per share at the time.

Forwarding to early 2023, the company generated $20.4 billion in sales, but this comes after the Chubb divestments, as earnings were reported at $2.34 per share. Modest advancements were seen in 2023, with revenues seen up to $22 billion and earnings seen at a midpoint of $2.55 per share, all while net debt came down to just $5.3 billion, very manageable with EBITDA trending around $3.2 billion. Trading at $45 in early 2023, the company commanded a fair 17-18 times earnings multiple, based on an enterprise valuation of $42 billion.

Adding Viessman

In April of last year, the company announced a big deal, as it announced the purchase of Viessman Climate Solutions in an EUR 12 billion, or $13 billion deal, in order to benefit from the German/European energy transition away from natural gas into heat pumps which are run by electricity.

With an EUR 4 billion in sales and EUR 0.7 billion EBITDA contribution, it was a 3.3 times sales multiple being paid which marked a premium over its own valuation at 2 times sales. This was in part compensated by higher margins of the activities, as Carrier furthermore announced the intention to sell the remaining fire & security business and the commercial refrigeration business.

That is needed, as an 80% cash component in the deal involves about $10.5 billion cash component, for pro forma net debt of $16 billion, equal to about 4 times leverage based on a pro forma EBITDA number of around $4 billion.

With the deal being dilutive at first, driven by additional interest costs, accretion was seen thereafter amidst a targeted EUR 200 million in cost saving in year 3, as well as deleveraging and some unknown revenue synergies. The lack of immediate earnings accretion meant that shares fell some $5 to $40 per share, shedding $4 billion in market value, which looked a bit of an overreaction.

This looked more compelling than has been the case for a while, yet I had some leverage concerns as well. This meant that I was looking to get involved at levels in the mid-thirties.

Missing The Dip

As it turned out, it was the selloff towards the $40 mark which marked the lows since the deal announcement with Viessmann. Ever since, shares have seen a big rally to the $60 mark over the summer, after which shares have been trading in a consolidating pattern, now trading hands at $56 per share.

The peak in July coincided with the release of the second quarter results, with reported sales up 15%, prompting the company into hiking the full year adjusted earnings guidance by five cents to $2.60 per share.

By October, third quarter sales were reported up 5% as the company raised the full year earnings guidance to $2.70 per share, as further deleveraging ahead of the Viessmann deal reduced net debt to $4.9 billion, as this even included near $1.2 billion in equity investments. With full year sales seen around $22 billion and operating margins seen at 14.5% of sales, operating profits are seen at $3.2 billion.

Trading at $56 the market value of the firm had risen to $48 billion, or $53 billion including net debt. With earnings power seen at $2.70 per share multiple, shares have re-rated, as a 21 times multiple marked a modest premium to the market ahead of the contribution of the Viessmann deal.

More Moving Parts

In December, Carrier announced two substantial divestments. The company reached a $4.95 billion deal with Honeywell ( HON ) to sell its Global Access Solutions business, comprising the remainder of its security business. The company fetched a reasonable 17 times EBITDA multiple, but somewhat disappointing was that net cash proceeds are seen at just $4.0 billion.

A week later, Carrier sold the global commercial refrigeration business to its long-time joint venture partner Haier in a $775 million deal, with these deals combined reducing pro forma net debt to the flat line (of course ahead of the Viessmann deal). Net cash proceeds are a bit disappointing as well in relation to the deadline price, with net proceeds seen around half a billion.

These deals are well-timed, as the deal with Viessmann closed in the first days of 2024.

And Now?

Amidst all these moving targets, the question is what 2024 brings as the net impact of all this should likely be net positive in terms of sales, but likely slightly dilutive in terms of earnings, although 2023 was quite good. Given all these comments, I am seeing sales growth for 2024, but likely think that earnings per share might take a small beating from an estimated number of $2.70 per share for 2023.

This is based on a largely neutral contribution of Viessmann, some dilution seen from divestments, further deleveraging, and the passage of time. Moreover, leverage is far lower than the 4 times communicated at the time of the Viessmann deal announcement.

Nonetheless, shares have run quite a bit ahead of themselves, certainly if earnings come in a bit soft. However, it is the many moving parts which create room for interpretation, potential setbacks, and potentially interesting buying opportunities, as Carrier smartly positions itself into an even greater business here.

Hence, I am really upbeat on the moves which the company is making, but the valuations have re-rated quite a bit, as moreover there is quite some uncertainty on the outlook for 2024. Given all this, I am very upbeat on the Carrier Global Corporation business, but anxiously await more input on the 2024 guidance, and/or a dip below the fifties before jumping into this long-term value creator.

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