Lennox Earnings: Commercial Business Recovery Surprises to the Upside; Full-Year Guidance Raised

Last quarter, Lennox’s commercial business, which had been in turnaround mode, reported 10% revenue growth and adjusted operating margin nearly doubled to 16.2%. This business fared even better during the second quarter, with revenue climbing 24% year over year to $408 million and adjusted operating margin reaching a very robust 25.3%. Commercial revenue growth was mostly driven by favorable price and mix, which together contributed 22 percentage points of revenue growth. Volume increased 4%, while unfavorable foreign-currency exchange was a 2-percentage-point headwind. We don’t think that a 25% operating margin is maintainable, but we now see stronger commercial profit margin during the second half of 2023. We also now have stronger conviction that the commercial business will achieve management’s targeted margin range of 18%-20% over the next few years. Our more optimistic outlook for the commercial business caused our fair value estimate to increase 3% to $275 per share.