Company Reports

Lennox picked up where it left off last year as first-quarter revenue and profit margin both increased from the prior-year period thanks to continued strength in building climate solutions (previously commercial heating and cooling). Core revenue, which excludes the divested European businesses, grew 6% year over year to over $1.0 billion. Core adjusted segment profit margin expanded 150 basis points to 15.9% on favorable price and mix.

Lennox has capitalized on its efforts to gain market share and improve its cost structure against a backdrop of improving end-market demand. Its margin expansion story has been remarkable, with adjusted operating margins rising from about 8% during the last sales peak in 2007 to nearly 18% in 2023. We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost manufacturing and product sourcing and more cost-efficient product designs helped reduce its cost base. All the while, Lennox has maintained it premium brand standing that supports pricing power.

New single-family home sales increased 4% in 2023 to 666,000 units, as homebuilders capitalized on a dearth of existing for-sale inventory while also offering more sales incentives, cutting base home prices, and building smaller homes to improve affordability. By the fourth quarter of 2023, homebuilders began to pull back on sales incentives as the average 30-year fixed mortgage rate retreated from 7.62% in October 2023 to 6.64% in January 2024. However, mortgage rates have trended higher recently, and we now forecast the average 30-year fixed rate will be 6.50% in 2024, up from our previous forecast of 6.10%. Even so, that’s lower than the 2023 average of 6.81%, and we think homebuilders won’t hesitate to increase sales incentives if needed; they still enjoyed above-average gross profit margins last year with elevated incentives. As such, in 2024, we think new-home sales will increase 9% to 730,000 units and single-family housing starts will increase 4% to 985,000 units. However, we expect total housing starts will decline roughly 5% to 1,345,000 units due to a 23% decline in multifamily starts to 360,000 units, as there’s currently approximately 1,000,000 multifamily units under construction—the largest backlog in at least 50 years.

Lennox enjoyed a good year in 2023 despite normalizing demand for residential heating, ventilation, and air-conditioning systems that was exacerbated by independent distribution channel destocking. Full-year core revenue (excluding revenue from divested European businesses) increased 6% year over year to over $4.7 billion, and adjusted core segment operating margin expanded 300 basis points to 17.9%.

Lennox has capitalized on its efforts to gain market share and improve its cost structure against a backdrop of improving end-market demand. Its margin expansion story has been remarkable, with adjusted operating margins rising from about 8% during the last sales peak in 2007 to nearly 18% in 2023. We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost manufacturing and product sourcing and more cost-efficient product designs helped reduce its cost base. All the while, Lennox has maintained it premium brand standing that supports pricing power.

New-home sales have rebounded since the spring of this year as sales incentives and price reductions have attracted buyers who have fewer options in the supply-constrained existing-home market. That said, homebuilder sentiment data tells us that smaller builders remain cautious. Even so, we forecast single-family starts to increase by 3% in 2024, to 0.92 million units. However, we project this increase in single-family starts will be more than offset by a 24% decline in multifamily starts, to 0.36 million units. Multifamily construction has been robust for the past three years, but a record construction backlog and higher construction and financing costs have tamed developers' appetite for new multifamily projects.

Lennox's third-quarter performance handily exceeded our expectations as both its residential and commercial segments delivered robust revenue growth and profit margin expansion. Core revenue (that is, excluding European operations, which will soon be divested) increased 10% year over year as higher prices and a favorable mix shift to more energy efficient and premium products more than offset lower volumes. And segment-adjusted profit margin expanded 330 basis points year over year to 19.3%, primarily due to favorable price and product mix.

Lennox has capitalized on its efforts to gain market share and cut costs against a backdrop of improving end-market demand. Its margin expansion story has been remarkable, with adjusted operating margins rising from about 8% during the last sales peak in 2007 to about 15% in 2019 before the pandemic (excluding an insurance recovery benefit and adjusting for divestitures of lower-margin refrigeration businesses). We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost manufacturing and product sourcing and more cost-efficient product designs helped reduce its cost base.

Lennox has capitalized on its efforts to gain market share and cut costs against a backdrop of improving end-market demand. Its margin expansion story has been remarkable, with adjusted operating margins rising from about 8% during the last sales peak in 2007 to about 15% in 2019 before the pandemic (excluding an insurance recovery benefit and adjusting for divestitures of lower-margin refrigeration businesses). We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost manufacturing and product sourcing and more cost-efficient product designs helped reduce its cost base.

New-home sales have remained resilient despite worsening housing affordability in recent months amid rising mortgage rates, with little relief in home prices in most markets. Year-to-date new-home sales through July were about even with the year-ago period, compared with a 22% decline in existing-home sales. The key to homebuilders’ relative success this year has been their ability to improve affordability by offering sales incentives, lowering base prices, and building smaller homes. According to the National Association of Home Builders, the share of builders offering incentives was 55% in August, up from 52% in July but down from 62% last year. One fourth of homebuilders reported lowering base prices by 6% on average. Homebuilders have also boosted production of speculative homes to capitalize on the tight supply of existing for-sale homes. Spec building also helps builders better manage construction cycle times and costs.

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.

Over the last decade, Lennox has capitalized on its efforts to gain market share and cut costs against a backdrop of improving end-market demand. Its margin expansion story has been remarkable, with adjusted operating margins rising from about 8% during the last sales peak in 2007 to about 15% in 2019 before the pandemic (excluding an insurance recovery benefit and adjusting for divestitures of lower-margin refrigeration businesses). We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost manufacturing and product sourcing and more cost-efficient product designs helped reduce its cost base.

Through the first four months of 2023 (typically viewed as the “spring selling season” for homebuilders) new home sales significantly outperformed existing home sales. Indeed, April year-to-date new home sales declined roughly 10% year over year compared to over a 26% decline for existing home sales. New home sales improved sequentially during the first four months of the year, and April sales increased 11% year over year, albeit on an easy prior-year comparison (April 2022 new sales were down 24% year over year).

Over the last decade, Lennox has capitalized on its efforts to gain market share and cut costs against a backdrop of improving end-market demand. Its margin expansion story has been remarkable, with adjusted operating margins rising from about 8% during the last sales peak in 2007 to about 15% in 2019 before the pandemic (excluding an insurance recovery benefit and adjusting for divestitures of lower-margin refrigeration businesses). We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost manufacturing and product sourcing and more cost-efficient product designs helped reduce its cost base.

Lennox reported solid first-quarter results that featured 3% core revenue growth (that is, excluding European operations, which will be divested) and good margin expansion (adjusted operating margin expanded 210 basis points to 14.4%). Lennox maintained its 2023 full-year outlook, which sees 0%-4% core revenue growth, adjusted EPS of $14.25-$15.25, and $250 million-$350 million of free cash flow. Our long-term outlook for Lennox is unchanged, but we’ll likely increase our $260 per share fair value estimate by a low-single-digit percentage due to the time value of money.

U.S. home sales slowed significantly in 2022 as rising mortgage rates and elevated home prices made homeownership less affordable for more Americans. By mid-2022, the average 30-year fixed mortgage rate had increased roughly 300 basis points year over year to over 6%. According to estimates from the National Association of Home Builders, this rate increase priced out more than 16 million households. We also think higher rates and general economic uncertainty caused some qualified prospective buyers to move to the sidelines. All told, 2022 new- and existing-home sales declined 17% and 18% year over year, respectively.

Lennox International closed out its fiscal 2022 with a strong fourth-quarter performance. The narrow-moat-rated heating, ventilation, air-conditioning, and refrigeration manufacturer reported 13% year-over-year revenue growth (to approximately $1.1 billion), segment operating margin expanded 150 basis points (to 12.1%), and adjusted EPS grew 12% (to $2.63). After reviewing the firm’s outlook and rolling our valuation model forward, we’ve raised our fair value estimate 5% to $260 per share, primarily due to our modestly more optimistic near-term outlook and the time value of money since our last update.

Over the last decade, Lennox has capitalized on its efforts to gain market share and cut costs against a backdrop of improving end-market demand. Its margin expansion story has been remarkable, with adjusted operating margins rising from about 8% during the last sales peak in 2007 to about 15% in 2019 before the pandemic (excluding an insurance recovery benefit and adjusting for divestitures of lower-margin refrigeration businesses). We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost manufacturing and product sourcing and more cost-efficient product designs helped reduce its cost base.

Over the last decade, Lennox has capitalized on its efforts to gain market share and cut costs against a backdrop of improving end-market demand. Its margin expansion story has been remarkable, with adjusted operating margins rising from about 8% during the last sales peak in 2007 to about 15% in 2019 before the pandemic (excluding an insurance recovery benefit and adjusting for divestitures of lower-margin refrigeration businesses). We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost manufacturing and product sourcing and more cost-efficient product designs helped reduce its cost base.

After analyzing recent United States housing market data and industry commentary, we've made downward revisions to our near-term outlook for new residential construction, home prices, and repair and remodel spending.