2013 marked the second consecutive year of relative calm in the residential HVAC industry, with an acceleration in growth from 2012 on the back of housing and an incrementally better consumer. With the distortions from R-22 now fading to the background, the focus has returned to the health of the consumer and the long-awaited normalization in the “repair/replace” dynamic, on which there were a few encouraging signs. In terms of investor sentiment, the HVAC-related stocks continue to perform well, with 2013 stock performance for names like Lennox (+60 percent), Ingersoll Rand (+60 percent) and Watsco (+27 percent) all in line or better than the 28 percent gain in the S&P 500.
2013 growth modestly better than expected
Through the third quarter, air conditioning and heat pump shipments were tracking up ~10 percent y/y in 2013, with revenues for the major publicly traded players up a similar amount. This compares with our industry forecast, which had called for approximately 6.5 percent growth. New housing construction has tracked up >20 percent, as expected, but replacement demand was more resilient than expected in the face of difficult weather comparisons in 2012. While another hot summer helped matters here, there also appeared to be some continued improvement in repair/replace activity, with our midseason survey pointing to modest declines in sales of replacement compressors for the second consecutive year. Additionally, mix held in well as R-22 dry shipped units continued to decline in the mix and R-410 systems reasserted themselves as the primary replacement option – this not only led to more revenues per replacement, given the sale of the indoor system, but also stabilized the spike in share of 13 SEER equipment following 2011. Bottom line, 2013 was a fairly solid year for the industry. Our standing 2014 model assumes 8-9 percent growth, with a slight moderation in the pace of new housing but continued improvement in replacement demand.
Is this the long-awaited replacement normalization?
For years, both investors and industry participants have debated the notion of “pent-up demand” and the potential lift from replacements that were deferred through the recession. Clearly some of this lift played out in 2012 to 2013, but the challenge has been to quantify what and where exactly replacement demand stands versus history. The exercise is complicated by a growing installed base in recent decades. By our estimates, annual replacement units have averaged around 6.2 percent of the installed base during the past 20 years, bottoming at 4.8 percent in 2009, and moving back to ~6 percent this year in 2014. This would suggest that some of this normalization is already playing out, and that demand is no longer as depressed, but with some potential for further improvement before we reach a truly normalized level.
Plenty of items remain on the horizon
While 2012 and 2013 actually were among the most stable years for residential HVAC in some time, plenty of potential changes are on the horizon. The regional efficiency standards remain a source of uncertainty, as the heating rule was delayed and the cooling rule (originally targeted for 2015) may see a similar push to the right. The adoption of a 14 SEER minimum, if/when it comes, should be positive for revenues but causes a familiar trade-off between units and pricing (higher equipment costs historically hurt demand as consumers opt for the lowest cost option) with potential for a pre-buy as early as late 2014. On the competitive front, the big news of 2012 was the Goodman/Daikin merger, which has now closed with the first selling season in the books. While it’s unclear what this ultimately brings, we believe this move can only enhance the penetration of the mini-split, now approaching a material part of industry volumes. There’s also the interesting issue of vertical integration as Daikin eventually looks to proliferate their inverter compressor technology into the Goodman unitary product, a pivot to the premium end of the market that could represent a shift for a brand historically associated with the value market. Stay tuned.
Stephen Tusa is an analyst with JP Morgan Electrical Equipment & Multi-Industry Equity Research. Contact him at 212/622-6623 or [email protected].
This is an article based on a JPMorgan Research report. For any JPM conflicts with any companies mentioned in this article, please refer to JPM’s disclosure website https:/mm.jpmorgan.com/disclosures/company/.