CARR - Carrier Global: Getting Carried Away With Viessmann Climate Solutions

2023-04-26 17:36:58 ET

Summary

• Carrier Global Corporation has been a solid value creator since its United Technologies spinoff.
• The company has deleveraged the balance sheet quite a bit as it now announces a big move into Germany by acquiring Viessmann Climate Solutions.
• The deal is a bit large and comes at a price, despite the strategic rationale.
• While appeal is improving following a declining share price, I am waiting for a slightly better entry point for Carrier Global Corporation.

Shares of Carrier Global Corporation ( CARR ) have taken a dive in response to the announcement of a big deal for German-based peer Viessmann Climate Solutions. The size of the deal - 12 billion euros ($13.17 billion) - and the negative share price reaction, is enough of a reason to update an investment thesis which goes back to December 2021, when I concluded that I was getting some chills on Carrier.

A Recap

Carrier is a mini conglomerate which once was part of United Technologies. The company was spin off from its former parent and focused on HVAC, refrigeration and fire & security. In the year 2019, the business generated $18.6 billion in sales and operating profits of $2.6 billion, for margins equal to 14%.

At the time of the spinoff, the company was mostly focused on HVAC which was responsible for about $10 billion in sales, with the other segments being largely equal, and thus responsible for the remainder of sales. The company furthermore had a decent geographic split, as well as decent split between upfront equipment purchases and service and aftermarket segment. Net debt of just over $10 billion at the time of the spin-off was on the high side, with leverage ratios seen in excess of 3 times, as I pegged earnings close to $2 per share. This created quite a compelling situation with shares trading at $14 at the time of the spin-off based on a share count of 866 million shares.

That initial upbeat stance quickly played out, despite the impact of the pandemic in 2020, as the company expected lower revenues and earnings. Despite this pressure, shares rose to $25 nonetheless, prompting me to take some profits on an initial position.

2021 Revisited

In the end, Carrier Global Corporation posted adjusted earnings of $1.66 per share in the year 2020, with the pandemic of course having an impact on the results. By the time of the release of these results early in 2021 shares had rallied to $37, making me cautious on the valuation. With net debt down to $7 billion and the company guiding for earnings of $1.90 per share in 2021, I saw the valuation as largely fair, not seeing imminent appeal.

In the summer of 2021, Carriers announced the sale of its Chubb fire and security business in a $3.1 billion deal. With $2.2 billion in sales and EBITDA margins around 10% leaving the door, the divestment looked a bit cheap in my view, as Carrier was trading at 2.5 times sales at $50 per share. The share price performance was furthermore driven by earnings power being hiked to $2.15 per share for the year, making investors upbeat.

All of this made me extremely cautious as a 7 times earnings multiple at the time of the spin-off has been re-rated to 22 times, and while leverage has come down meaningfully, I was cautious on shares of Carrier at those levels.

Stagnant

After Carrier Global Corporation shares peaked around $55 per share in the summer of 2021, shares have largely been trading rangebound between $35 and $45 in 2022 and the earlier part of 2023. This came as the company was dealing with inflation and uncertain economic conditions as well, as the increased focus on HVAC and ventilation during the pandemic faded.

In February 2022, the company posted strong 2021 results, a year in which revenues rose to $20.6 billion. The company posted net earnings of $1.7 billion, for earnings equal to $1.87 per share. Adjusted earnings per share even came in at $2.26 per share, with the difference mostly relating to restructuring costs, separation costs and costs related to the divestment of Chubb. Amidst this pending divestment, the company guided for largely flattish sales around $20 billion and earnings around $2.25 per share.

Forwarding another year, Carriers posted adjusted earnings of $2.34 per share on $20.4 billion in sales. This looks largely fair but comes amidst the divestment of Chubb, as the company guided for 2023 sales to rise to $22 billion, with earnings seen between $2.50 and $2.60 per share. Following the Chubb deal, net debt has come down to $5.3 billion, with EBITDA reported around $3.2 billion. The company has managed to cut debt and has shrunk the outstanding share base to 852 million shares.

The valuation has become a lot more compelling at the start of this year. Trading at $45, the company commands a more than $38 billion equity valuation, and $42 billion enterprise valuation. With leverage much more under control, forward earnings multiples have fallen to 17–18 times.

A Huge Deal

After Carrier has deleveraged quite a bit following the Chubb divestment and some retained earnings, it had financial firepower to spend on dealmaking again. In April, the company announced an EUR 12 billion deal to acquire Viessman Climate Solutions, a deal valued just above $13 billion. This is equal to about a third of Carrier´s own enterprise valuation here.

The deal gives the company access to a business with a strong heritage in global heat pumps and energy transition markets, in a deal valued at around 13 times EBITDA. Viessman is set to add about EUR 4 billion in sales this year and EUR 0.7 billion in EBITDA. The 3.3 times sales multiple comes at a big premium compared to Carrier´s 2 times sales multiple, although Viessman posts higher margins.

Carrier believes that Viessman will play a key role in the German and European energy transition, but some part of the business will be impacted by stricter environmental laws and regulations as well.

The company moreover announced its intention to divest the (remaining) Fire & Security business and Commercial Refrigeration business. With 80% of the deal paid for in cash, and the remainder in stock, net debt will increase by about $10.5 billion. This makes for pro forma net debt load of around $16 billion, although that EBITDA should surpass the $4 billion mark, ahead of the anticipated divestments. Amidst some time until deal closing, the company expects an initial leverage ratio around 3.5 times. Even without divestments, leverage is seen around 2 times two years after closing.

The deal is set to be slightly dilutive to earnings in the first year post closing, in part because of assumed interest costs, as modest accretion is seen in 2025. EUR 200 million in costs synergies are seen (fully realized in year 3) while some unspecified cross-selling revenue synergies are expected to be realized as well.

What Now?

Shares of Carrier Global Corporation have fallen about $5 in response to the Viessmann Climate Solutions deal announcement , now trading at $40 per share. This move has shed about $4 billion in market value from the firm, which feels like a bit of an overreaction to a $13 billion deal. While the Viessman deal is not cheap, it is not overly expensive, either. Perhaps investors fear the combination of a large deal, higher leverage ratio post the deal, and announcement to sell other assets (perhaps fearing disappointing proceeds from these asset sales).

The Viessman deal is set to add about $4 billion and lucrative sales to the line-up, as the two anticipated divestments will cut sales by a similar amount. That said, the margin and growth profile should improve, as the question is how large the net investments of this transformation is: that is, the net investments into the Viessman deal, minus the proceeds from the two anticipated divestments.

With Carrier Global Corporation now trading at $40, the company trades at 16 times forward earnings, which looks reasonable. The situation looks a lot more compelling than has been the case for a while, yet I have some concerns on the deal and leverage as well. That said, I am gradually attracted to the pullback, looking to get involved again with Carrier Global Corporation shares in the mid-thirties.

For further details see: