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Tony Daltorio

1 Industrial Stock to Buy Now for an Elevator Ride to the Top

There’s an old joke: “How’s the elevator business?"… "It has its ups and downs.”

Funny enough, there’s a lot of truth in that joke. The elevator business is highly cyclical, with much of the demand coming from China.

In 2023, a record 180 towers with a height of more than 200 meters (over 656 feet) were completed, up 15.4% from 2022, which had 156 completions. It was the 10th year in succession that more than 100 buildings of this height were completed, according to the Chicago-based Council on Tall Buildings and Urban Habitat.

Some 55% of last year’s completions were in China. The city of Shenzhen alone now has 1 out of every 14 of the world’s buildings over 200 meters.

This pace of building tall structures is unlikely to last. It is well-known that the Chinese market has been in turmoil since the government introduced its “three red lines” four years ago to rein in overleveraged developers. Over half of China’s listed property developers have either defaulted or entered into debt restructuring, according to economics research firm Gavekal Dragonomics.

This skyscraper construction boom is a big reason why China accounts for 60% of global elevator demand, according to RBC Capital Markets.

So, the downturn in China’s building boom has been evident in the results of the three main listed pure-play companies that produce elevators – Kone Oyj (KNYJY), Schindler Holding (SCHP.Z.IX), and Otis Worldwide (OTIS) – for a while now.

Otis Elevators

Some of you may recognize Otis as a spinoff of the old United Technologies conglomerate.

On April 3, 2020, United Technologies, renamed as Raytheon Technologies (RTX), completed the tax-free spin-off of both Otis Worldwide and the heating and air conditioning firm, Carrier Global (CARR).

The 170-year old Otis - the world’s largest manufacturers of elevators, escalators, and moving walkways - used to generate about 20% of its sales in China. But this figure will fall to roughly 14% in 2024, CEO Judy Marks said in September. The company had blamed the slowing Chinese market when it cut guidance in July following a flat first half.

“This is the third year in a row where the China market is down 10%,” Marks said. Otis’s new installations are expected to fall to about 425,000 this year, from a peak of 650,000. She also said that a “pivot to service” would leave it less exposed to China in the future.

Many industry analysts favor Otis over Kone and Schindler, and it’s easy to see why. The company will have faster earnings per share growth over the next five years than the European pair. And historically, Otis has delivered much higher margins and returns on invested capital – 54.2% over the past five years. That blows away the 26.7% at Kone and 16.5% at Schindler.

Otis Elevator Services

All of the elevator companies talk up the opportunities in modernization of the existing elevators, and for good reason.

If we look at China, it has 10 million elevators that are at least 15 years old! The average life of elevator systems is 15 to 20 years. Otis CEO Marks says that the margins for modernization are the same as for new installations in China. In addition, Marks says that 40% of the modernizations it carries out there are on non-Otis units.

The current economic situation has led Otis to shift its focus in China from new equipment sales to services. The end result is that, over the past four years, its service business in China has doubled. The split now between new equipment and services in China is 70% to 30%, with the services number rising swiftly.

This is the route that Otis needs to go in order to turn its fortunes up. In its latest quarter, net sales for the company's new equipment fell 11.4% to $1.42 billion from a year ago. However, net sales for its services segment, which carries out maintenance, repairs and product upgrades, rose 3% to $2.18 billion, on steady to rising demand.

In 2023, modernization orders rose by 23%. The company maintained and serviced 2.3 million units worldwide, operating in over 200 countries.

And make no mistake; this is a very profitable business for Otis. The company’s service business already accounts for 60% of revenue and 90% of profit globally. This ensures reliability in its results, no matter what the economy is doing.

Buy OTIS Stock

Otis’s installed base — the largest installed base of elevators globally — drives strong free cash flow generation throughout the economic cycle. The company will benefit from a globally aging installed elevator base. Elevator modernization is a long-term growth opportunity for Otis, even outside of China. About half of Europe’s and North America’s elevator installations are more than 20 years old.

One of the company’s key strengths is its ability to generate robust free cash flow, thanks to its low capital expenditures. In 2024, it is likely Otis will convert over 100% of its net income to cash, allowing it to execute its capital allocation strategy of share buybacks, dividend raises, and debt reduction.

That makes OTIS a buy in my book. The stock is up 27% over the past year. Buy it below $107.

www.barchart.com
On the date of publication, Tony Daltorio did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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