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Lennox or Watsco: Which HVACR Stock is Worth a Bet Now?

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A major boost in the residential market, and infrastructural and construction spending should continue to favor the Zacks Building Products - Air Conditioner and Heating industry in 2020. Also, prudent cost-management practices, leveraging technologies and accretive acquisitions are likely to benefit industry players like Lennox International Inc. (LII - Free Report) , Watsco, Inc. (WSO - Free Report) , Comfort Systems USA, Inc. (FIX - Free Report) , Tecogen Inc. and AAON, Inc. (AAON - Free Report) .

The U.S. housing market has been experiencing higher demand, courtesy of lower mortgage rates and solid job market. The heating, ventilation, air conditioning and refrigeration (“HVACR”) markets are bound to get a boost from underlying strength in the housing market. Moreover, higher construction spending activity in non-residential, commercial and industrial sectors is a boon to the industry, in turn boosting the companies’ revenues and profits.

However, the aforementioned growth factors seem to be weighed down by headwinds arising from rising costs, heavy governmental regulation and competitive pressure.

Among the industry bellwethers, Lennox and Watsco are the most recognized. Notably, both the companies carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Let’s delve deeper into both the company’s growth and profitability measures.

Business Performance & Market Cap

With a market cap of $9.39 billion, Lennox designs, manufactures and markets a broad range of products for the HVACR industry. Notably, its products and services are sold through multiple distribution channels under various brand names.

The company’s strategy is to sustain and expand market position, while offering a full spectrum of products to meet customers’ needs. It focuses on cost-reduction initiatives to drive margin expansion and support growth. Moreover, new investments for the expansion of distribution footprint, research and development projects, as well as recent marketing programs are expected to be conducive to the company’s top line.

In contrast, Florida-based Watsco — with a market cap of $6.86 billion — operates as a leading distributor of HVACR products to the industry in North America. Watsco distributes products in 603 locations (as of Sep 30, 2019) and sources supply from major industry players like Rheem, Carrier, Nordyne, Goodman, Trane, and Lennox.

Continued investment in the technologies designed to revolutionize customer experience and strong industry fundamentals, including healthy replacement demand, confident consumers and rising price/mix, will likely translate into better cash flow and returns.

Stock Performance This Year

Lennox’s shares have gained 19% over a year, comparing unfavorably with Watsco’s 35.7% rally. The Homebuilding industry has gained 16.3% during the period. Hence, Watsco fared much better than Lennox in this parameter.

Prospects & Surprises

Analysts expect Lennox’s earnings to grow at a 3.5% rate in 2020. Comparatively, Watsco’s earnings are expected to grow 7.2% over the same time frame. Hence, Watsco’s higher growth rate implies greater potential for capital appreciation.

Meanwhile, considering a more comprehensive earnings history, Lennox delivered a positive surprise in two of the last four quarters, while Watsco did not come up with positive surprise in any of the trailing four quarters. Hence, Lennox is better than Watsco in terms of surprise history.

Profitability and Returns

Return on Capital of Lennox is 48%, while that of Watsco and the industry is 13.4% and 19.3%, respectively. This signifies that Lennox’s business generates a higher return on investment than Watsco.

Return on Equity (ROE) in the trailing 12 months for Lennox is a negative of 199.1%, while that of Watsco is 15.1%. Markedly, both the companies provide lower returns to investors compared with the industry’s 27.9%.

A Look at the Stocks’ Valuation

The trailing 12-month price-to-earnings (P/E) multiple for Lennox and Watsco is 22.81 and 27.68, respectively, while that of the industry is 23.46. Trailing 12-month price-to-sales (P/S) multiples for Lennox and Watsco are 2.53 and 1.34, respectively, compared with the industry’s 1.57. Watsco is the cheaper of the two stocks on a P/E and P/S basis.

Final Verdict

Watsco appears to be a comparatively better investment option than Lennox.

Both the companies remain optimistic about growth trends in the industry, given solid demand, favorable job market and strength in economic fundamentals, offsetting industry woes.

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