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Air Conditioner and Heating Outlook: Growth Prospects Solid

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Robust construction activity in both residential and nonresidential sectors along with strong technological advancement are driving demand for the Air Conditioner and Heating industry, which includes air-conditioning and heating equipment manufacturers.

An improving economy, accelerated construction spending in the United States, continued investment in technologies designed to revolutionize customer-experience and Trump’s impetus to boost infrastructure spending seem to be vital growth catalysts to the industry. Meanwhile, digitization of the companies’ marketplace via e-commerce and iOS/Android-enabled apps, supported by the industry’s comprehensive database of product information, continues to see momentum.

Additionally, the industry generates a major share of its revenues from maintaining, monitoring and repairing existing equipment that consumers generally cannot suspend. These lend a stable source of revenues when construction markets fluctuate.

However, higher raw material costs, trade tensions, rising freight expenses, stiff competition and the impact of seasonality on the industry’s revenues pose significant challenges in the forthcoming quarters.

This industry is susceptible to heavy governmental regulation related to energy efficiency and gas emission. HVAC (Heating, Ventilation and Air Conditioning) systems use refrigerant for cooling that are harmful for the humans and environment.

The industry also faces stiff competition as vendors in the HVAC business compete on performance, reliability, service and price. Importantly, inflation and tariffs have been increasing commodity headwinds. As HVAC projects can take several months to be completed, they are subject to raw material cost fluctuation.

Seasonality is also an important factor that could prove to be detrimental to the industry players. Sales of residential central air conditioners, heating equipment, and parts and supplies have historically been seasonal. The companies’ profitability will be impacted favorably or unfavorably, based on the severity or mildness of weather patterns during the summer or winter selling seasons.

Industry Outperforms Sector

Looking at shareholder returns over the past year, it appears that higher demand courtesy of strong construction activity in the United States are boosting investors’ confidence in the Air Conditioner and Heating industry’s growth prospects.

In a year’s time, the Zacks Air Conditioner and Heating Industry, a five-stock group within the broader Zacks Construction Sector, has underperformed the S&P 500 index. The industry has been trading almost in line with its own sector over the same time frame.

While stocks in this industry have collectively gained 15%, the Zacks S&P 500 Composite has rallied 15.9% and the Zacks Construction Sector has declined 5.3%.

One-Year Price Performance


 
Air Conditioner and Heating Industry Stocks Appear Expensive

One might get a good sense of the industry’s relative valuation by looking at its price-to-earnings ratio (P/E), which is the most appropriate multiple for valuing Air Conditioner and Heating stocks.

This ratio essentially measures a stock’s current market value relative to its earnings performance. Investors believe that the lower the P/E, the higher the value of the stock will be.

Despite the industry modestly underperforming the S&P 500 scale, the valuation seems high. Currently, the industry has a trailing 12-month P/E ratio of 27.7, which is at a significant premium as compared to the S&P 500’s P/E ratio of 20.2.

Price-to-Earnings Ratio (TTM)


 
Comparing the group’s P/E ratio with that of its broader sector also shows that the industry is much overvalued. The Zacks Construction Sector’s trailing 12-month P/E ratio of 16.2 and the median level of 18.4 for the same period are way below the Zacks Air Conditioner and Heating Industry’s respective ratios.

Price-to-Earnings Ratio (TTM)


 
 

Improving Earnings Outlook to Drive Outperformance

Indeed, higher raw material and freight costs have been creating pressure on the companies’ margins in the air conditioner and heating market. If this wasn't enough, Trump’s steel and aluminum import tariffs, announced earlier this year, have raised apprehensions.

Nevertheless, the air conditioner and heating space looks attractive this year given solid economic fundamentals and Trump’s vow to boost infrastructure spending along with technological development. Strong industry fundamentals and expectations of solid top-line growth should continue to generate positive shareholder returns in the near future.

However, what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead.

One reliable measure that can help investors understand the industry’s prospects for a solid price performance going forward is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and its aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Over the period of one year, the industry has been experiencing positive earnings estimate revisions, increasing collectively by 1% for the current year over the said time frame.

Price and Consensus: Zacks Air Conditioner and Heating Industry



Zacks Industry Rank Indicates Bullish Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued outperformance in the near term.

The Zacks acks Air Conditioner and Heating Industry currently carries a Zacks Industry Rank #35, which places it at the top 14% of 256 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Our proprietary Heat Map shows that the industry’s rank over the past five weeks.


 
Air Conditioner and Heating Industry Promises Long-Term Growth

The long-term prospects for the industry indicate steady growth. When compared with the broader Zacks S&P 500 composite, the long-term (3-5 years) EPS growth estimate for the Zacks Air Conditioner and Heating industry of 14.9% appears promising. The corresponding figure for the Zacks S&P 500 composite is 9.8%.

Mean Estimate of Long-Term EPS Growth Rate


 

In fact, the basis of this long-terms EPS growth could be a sharp improvement in the top line that these Air Conditioner and Heating stocks have been showing since the end of 2014.

Revenues: Zacks Air Conditioner and Heating Industry


 

Bottom Line

A major boost in infrastructural and construction spending should continue to favor the industry’s performance. Additionally, maintaining, monitoring and repairing services along with prudent cost-management practices leveraging technology should provide support. These aforementioned growth factors seem to be offsetting the headwinds arising from rising costs, heavy governmental regulation and competitive pressure.

Currently, only one stock in the Zacks Air Conditioner and Heating Industry carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Watsco Inc. (WSO - Free Report) : The largest distributor of heating, ventilation and air conditioning equipment as well as related parts and supplies in the United States has gained 7.9% over the past year. The consensus EPS estimate for the company has increased 0.2% to $6.67 for 2018, over the past 60 days.

Price and Consensus: WSO

 
Investors can also consider stocks that currently carry a Zacks Rank #3 (Hold) and are experiencing positive estimate revisions and solid earnings growth prospect.

AAON, Inc. (AAON - Free Report) : Earnings estimates of this Tulsa, OK-based manufacturer of air-conditioning and heating equipment have increased 10.1% over the past 90 days for the current year.

Price and Consensus: AAON


 
Comfort Systems USA, Inc. (FIX - Free Report) : Earnings estimates for this Houston, TX-based leading provider of mechanical services — including heating, ventilation, air conditioning, plumbing, piping and controls — have exhibited an uptrend over the past 90 days. The consensus EPS estimate for the company has increased 6.3% to $2.72 for 2018, over the period.

Price and Consensus: FIX


 
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