Housing stocks are having a terrible year, weighed down by higher mortgage rates and raw-material costs. Down nearly 29% year to date, the iShares U.S. Home Construction ETF (ITB) has plunged nearly 20% in just the last two months. But amid the sell-off, a few niche housing stocks are starting to look like bargains, particularly those in the HVAC—heating, ventilation and air-conditioning—business, such as Ingersoll-Rand PLC (IR) and Lennox International Inc. (LII), according to Barron’s.
Because HVAC units typically last between 12 to 15 years, Baird analyst Tim Wojs sees strong demand for replacement-HVAC units over the next few years as units purchased during the height of the housing boom between 2003 and 2006 will soon need to be replaced. “We probably have a couple more years of strong replacement demand,” Wojs said.
2 Resilient Housing Stocks
|Ingersoll Rand||+ 21.9%|
|Lennox International||+ 12.1%|
|iShares U.S. Home Construction ETF||- 22.0%|
Source: CNN Money, as of 4pm EST 11/09
What It Means
With the Federal Reserve committed to monetary tightening, the housing market has already begun to slow as higher mortgage rates depress demand. As of August, home prices were seeing their smallest year-over-year gains in 20 months.
But while demand for new housing falls, people still need to maintain the ones they’re already living in, which means replacing things like old HVAC units. As replacement units account for about 80% of all residential HVAC sales, a slowdown in new-housing construction affects just a small proportion of total sales, and as mentioned above, the HVAC-replacement cycle for homes purchased in the pre-financial-crisis boom is just starting to get underway.
But it’s not just residential spaces that need things like heating and air-conditioning—HVAC units are also needed in commercial spaces like offices, retail shops and restaurants. New construction growth for these non-residential spaces has seen an average growth rate of 8% over the past three months.
Also promising for the HVAC market is the trend towards making homes ‘smarter’. There is a lot of room for innovation in regards to heating, ventilation, and air-conditioning, which could lead to more monetizable opportunities for innovative HVAC firms.
Activist investors are also taking an interest in HVAC recently, which could lead to more industry consolidation. Lennox, because of its size and U.S. focus, could be an especially attractive takeover target, and was recently given mention by Morgan Stanley, suggesting that a Lennox-Carrier deal would make sense.
3 Other Hidden Values
|Stock||2019 P/E ratios (estimate)|
|Johnson Controls International||11.0|
Carrier is a brand owned by United Technologies Corp. (UTX), a multinational conglomerate that also produces HVACs and was another housing stock with hidden value mentioned by Barron’s, along with Watsco Inc. (WSO) and Johnson Controls International PLC (JCI).
However good these stocks look they will definitely feel some strain if housing demand continues to weaken, a not unlikely prospect with the Fed continuing its interest rate hikes. Additionally, those interest rate hikes could have a depressive effect throughout all sectors of the economy, weighing on overall job and investment growth. The worst-case scenario is one where the economy enters a recession, a situation that would be bearish even for those bargain-valued HVAC stocks.