Within the HVAC universe, stocks have trended in line with the broader market as a whole. The group that has shown the greatest beta since 2011 is the pure-play manufacturers, consisting of Aaon, Lennox, Mestek, and Nortek. This group of stocks has increased almost 72 percent since January 2011. Diversified HVAC manufacturers and HVAC service and distribution stocks have also performed well, gaining 40 and 27 percent, respectively, but lag slightly behind the S&P 500 with a gain of 55 percent over the period. Most recently, all of the HVAC groups have trended down in the third quarter of 2014.

On the M&A front, Nortek remains an active acquirer, announcing in October it had closed its acquisition of Phoenix Wholesale Inc., an HVAC equipment distribution business. The business will be integrated into Nortek’s residential heating and cooling segment. Nortek expects the transaction to generate incremental revenue of between $15 million and $20 million over the next year. Additionally, in August, private equity firm The Riverside Co. acquired The Dwyer Group, a residential and light commercial repair and maintenance business. Brands include Aire Serv, which provides installation, maintenance, and repair of HVAC systems; as well as Glass Doctor and The Grounds Guys, which offer auto, residential, and commercial glass replacement and landscaping services, respectively. This marks Riverside’s second investment in The Dwyer Group, having originally purchased the business in 2003, later exiting in December 2010 in a $150 million sale to another private equity firm, TZP Group, according to S&P Capital IQ.

HVAC Stock Valuations

Valuations of HVAC stocks, in terms of earnings multiples, have trended down slightly from the beginning of 2014. Total enterprise value as a multiple of Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) trended up from the third quarter of 2013 and peaked in the first and second quarters of 2014. The peak in price-to-earnings multiples varied across the HVAC subsets, with diversified manufacturers and pure-play manufacturers reaching their peaks of 17.9x and 26.5x, respectively, in the second quarter of 2014 and service and distribution players peaking in the fourth quarter of 2013.

HVAC Equipment — A Global Market

Global demand for HVAC equipment is forecast to increase by approximately 6 percent per year and reach a total value of $113 billion by 2019, according to The Freedonia Group Inc., a Cleveland-based industry market research firm. The Asia/Pacific region, driven primarily by China and India, will serve as key drivers of growth as these two countries account for approximately half of the global HVAC demand. While other emerging economies in this region still lack the electrical power infrastructure needed for widespread use of HVAC systems, China and India are equipped to see growth spurred by rising incomes, improving distribution networks, and a continued increase in construction spending.

Increased Regulation, Desire for Efficiency

The U.S. remains an integral part of the HVAC market as it accounts for approximately 15 percent of global demand, making it the second-largest national market after China. The most significant factor for continued growth in the U.S. will be the rise in construction activity in private, nonresidential, and commercial markets as new structures will require some form of HVAC equipment. The increasing levels of consumer spending will also play a role as more disposable income will likely be used for home improvements.

As the market continues to grow, increasing HVAC system efficiency will be vital due to the increasing amount of regulation designed to reduce energy costs and the impact on the environment. New Department of Energy (DOE) standards for some HVAC products are scheduled to take effect in 2015, with more policy changes likely in the future. Due to this desire for more efficient products and designs, heat pumps and mini splits are likely to be the fastest growing room units. Mini splits offer similar functionality to window units but are much more efficient while heat pumps offer an energy-efficient and often cost-effective way to control temperature in moderate climates.

Publication date: 11/17/2014

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