As temperatures continue to rise, investors in the air conditioning industry are rejoicing. However, it’s important to approach these stocks with caution.
The Electric Reliability Council of Texas (ERCOT) recently issued a weather warning due to the expected surge in temperatures, which will lead to higher electrical demand. They also anticipate a potential decrease in electricity reserves.
With the scorching weather prompting people to seek refuge indoors and crank up their AC units, ERCOT reported that on July 13, Texas reached a new unofficial July and all-time peak demand record of 81,406 megawatts. While this number may not seem significant, the fact that it is a “record” should catch investors’ attention.
The booming demand for air conditioning has positively impacted AC-related stocks. People are increasingly concerned about the possibility of power outages during hot weather, making them more willing to invest in fixing or upgrading their AC systems.
Heating, ventilation, and air conditioning companies like Carrier (CARR), Trane Technologies (TT), Lennox International (LII), and Johnson Controls (JCI) have all experienced incredible market performance. On Monday, they reached 52-week highs, and although Johnson Controls is slightly off its peak, it remains strong.
In addition to these stocks, backup power provider Generac (GNRC) has seen a significant increase in its share value. Since the end of May, these five stocks have collectively risen by an average of 22%, outperforming the S&P 500, which only saw a 5% increase during the same period. Even the tech-focused Nasdaq Composite has struggled to keep up with the industry’s heat, rising by approximately 7% in comparison.
Despite the high valuation multiples, investors remain optimistic. Earnings estimates for these companies have not significantly changed since the beginning of summer. This indicates that investors are willing to pay higher prices for these stocks. The average price-to-earnings (PE) ratio for the group now stands at around 22 times the estimated 2023 earnings, up from approximately 18 times before the summer season began.
The Risk for the HVAC Group and Generac’s Sales Guidance
The upcoming earnings report poses a risk for the HVAC group, as investors are expecting an increase in bottom-line EPS guidance for 2023. With the way the stocks are currently performing, it is reasonable for investors to anticipate positive growth. In contrast, Generac, a player in the HVAC industry, has not performed as well. Since their recommendation in September 2022, Generac shares have fallen by about 17%, while Carrier shares have seen significant gains of approximately 27% since May.
One possible reason for Generac’s underperformance could be its association with the 2022 hurricane season. Typically, Generac stock rallies during times of increased storm activity. However, our oversight of channel inventories resulted in a negative impact on guidance cuts at the generator maker. This serves as a reminder to pay closer attention to external factors that may affect stock performance.
Despite the challenges faced by Generac, both the HVAC and generator businesses demonstrate reasonable fundamentals and strength in their long-term outlook. Although stocks may continue to perform well, caution is advised as we approach second-quarter earnings reports.
Timing the stock market accurately is a difficult task, and we do not recommend making wholesale changes to anyone’s outlook or portfolio. Instead, we emphasize the importance of keeping an eye on the weather and other external influences to ensure investors are not caught off guard by earnings results.
By Al Root