Residential HVAC Profits Should Be Resilient As Volumes Dip

THE COWEN INSIGHT

The severity of a C23 unit drop in North American residential HVAC is an investor debate, given its importance to OEM profits (89% at LII; ~30% at CARR; 25% at TT). North American residential HVAC OEM profits are likely to rise in C23 even as volumes drop. We don’t expect volumes to “mean-revert” to the pre-COVID trend line but we do expect a shallower drop than feared and an area of resilience vs. other industrial sectors.

NORTH AMERICAN RESIDENTIAL UNIT DROP WILL BE SHORTER THAN EXPECTED

The projected North American residential HVAC unit volume drop in C23 will be less onerous to HVAC OEM profits than is feared. That is, we believe North American residential HVAC unit volumes will fall Y/ Y in C23, but at a less severe rate (i.e., investors fear a ≈10-15% unit drop; we assume 5%) than feared. This is due to many factors such as repair vs. replace economics, a limited opportunity to prebuy ahead of SEER change, the notion that macros aren’t terrible, and a shorter HVAC system life expectancy. HVAC OEM profits from North American residential markets will likely be flat in C23, even if volumes fall more sharply than we assume. This is also precipitated by commodity deflation, richer mix (SEER mandate effective on 1/1/23), and higher prices that should hold due to a disciplined and attractive industry structure.

TWO INVESTOR QUESTIONS WE ADDRESS

1. Is A Big Shipment Volume Drop Likely in C23? –North American residential HVAC shipments had abnormally high growth in 2020 and 2021 (near 10%/yr) relative to what was expected, raising mean-reversion concerns for C23. If 2023 shipments revert to the pre-COVID 3-4% long term “trendline”, a >10% unit volume decline is possible.
2. Will North American Residential HVAC Profits Collapse In C23? – HVAC OEMs have hiked prices repeatedly, rendering HVAC system prices today that are >35% above early C20 levels. Investors worry that OEM HVAC prices will fall if/when unit volumes decline, as recent deflation (in inputs such as copper, steel, and aluminum) should reduce the variable cost of producing HVAC systems. Investors appear too dismissive of the profit support from improving SEER mix, deflation, and pricing power/discipline among OEMs.

WHAT IS PROPRIETARY

We incorporate market pricing by SEER for residential HVAC products, our pre-COVID model of expected annual residential shipment gains, and other data (input costs; repair vs. replacement trade-offs) to support our thesis.