170 OTIS Worldwide Corporation (NYSE: OTIS) stands as a global leader in the elevator and escalator industry with a legacy spanning over a century. Specializing in the design, manufacture, and servicing of a wide range of vertical transportation solutions, OTIS operates in over 200 countries, emphasizing innovation, safety, and top-notch customer service. In the ever-evolving urban landscape, OTIS continues to play a vital role in powering mobility across global cities, maintaining its apex status in the industry. The latest quarter witnessed robust organic growth in new equipment (NE) sales for OTIS, even though NE orders showed a notable decline compared to the previous year. This prompted a downward adjustment in expectations for most key markets, particularly China, which now carries a more cautious outlook. However, the Asia Pacific region remains an exception, displaying continued growth potential. Encouragingly, global pricing for new equipment orders is on the upswing, and there’s a general sense of optimism regarding future growth, as indicated by management. The service and repair sectors have also experienced significant growth, although a slowdown is anticipated in the latter half of the year. Despite these mixed signals, management maintains a bullish outlook for 2023, anticipating a rebound in revenue after the previous year’s decline. However, given the current share price’s proximity to its fair value based on management’s guidance and the absence of a significant margin of safety, I recommend a hold rating. Financials Over the period from 2017 to 2022, OTIS has achieved a compound annual revenue growth rate of approximately 2%. The 4% revenue decline in 2022 can be attributed to challenging comparisons with the previous year, which benefited from the reopening of major economies post-COVID lockdowns, resulting in increased demand for vertical transportation. Looking ahead, it’s anticipated that year-over-year revenue growth will closely align with its historical CAGR. This aligns with management’s projections, which foresee full-year 2023 revenue ranging between $14 billion and $14.3 billion, indicating growth of 3-5.5%. Factors contributing to this outlook include the normalization of COVID-related impacts, easing the burden of demanding year-over-year comparisons, and strong organic growth in NE sales, driven by robust pricing growth. Regarding EBITDA margins, OTIS has consistently maintained them at 18%, demonstrating cost management proficiency even amidst sales fluctuations. In a recent announcement, OTIS introduced the UpLift program aimed at enhancing operational efficiency and generating cost savings. Considering these factors, it’s anticipated that the company will sustain these margins in the future. This view aligns with management’s projections, which anticipate operating margins of 15.9%, an increase from the current quarter’s 15.6%. Valuation Given my outlook on the business, I foresee a 4% growth in revenue over the next two years, in line with management’s guidance for 2023. This projection is influenced by the rising global prices for new equipment orders. Management holds an optimistic stance, expecting some growth in the Americas and EMEA, along with a modest increase in Asia. Despite the decline in NE orders, the strong growth in services and repairs contributes to an optimistic perspective on 2023 net sales. Based on author’s own math In the competitive elevator and escalator industry, maintaining net profitability is critical, considering both companies’ net margins are below 10%. Assessing the P/E ratio, which focuses on net earnings, can offer clearer insights into which company effectively retains more profit from operations. Currently, OTIS’s forward P/E stands at 22x, exceeding peers such as Kone (OTCPK: KNYJF), which has a forward P/E of 19.5x. This higher multiple can be attributed to OTIS’s superior margins compared to its peers. With a net margin of 9.6%, surpassing the peer average of 7.4%, and a higher Last Twelve Months (LTM) revenue of 13.8 billion compared to the peer’s 11.8 billion, OTIS’s elevated valuation seems justified. Based on OTIS’s current forward P/E, my target price is $77. However, given the lack of margin of safety and the company’s challenges in new equipment (NE) orders, leading to downward adjustments in market forecasts, I recommend a hold rating on the stock. Comments While NE sales showed robust performance this quarter, with a 9.5% organic growth across all regions, NE orders experienced a notable 12% decline, contrasting sharply with a 16.5% increase during the same period last year. Management has revised market expectations downward for EMEA, the Americas, and China, except for the Asia Pacific region, primarily driven by India’s positive contribution, expected to continue with mid-single-digit growth. EMEA anticipates a high-single-digit market decline in 2023, notably affected by weak spending decisions in Northern Europe. Similarly, the Americas foresees a similar high-single-digit decrease, largely due to changes in the multifamily residential sector. China’s market outlook has also turned pessimistic, expecting a 10% decline, compared to the previous forecast of 5-10%. Global pricing for new equipment orders has seen slight increases, except in China, which faced deflationary pressure. Despite these challenges, the company maintains an optimistic outlook for organic sales growth, projecting mid-single-digit growth in the Americas and EMEA and a slight increase in Asia. The service segment demonstrated robust growth, although a slowdown is expected as repair activities return to normal. Organic service sales saw an impressive 9.4% increase this quarter, with growth observed across all regions. Maintenance and repair activities surged due to an unexpected volume of repairs, with portfolio units expanding by 4.2% and a 4% increase in like-for-like pricing. Modernization efforts also showed a significant uptick, recording a 10.9% growth this quarter. Notably, China exhibited consistent growth, with its portfolio marking double-digit growth for the eighth consecutive quarter. The repair segment has been performing exceptionally well over the past six to eight quarters, with a significant surge in the first half of 2023. Looking ahead, I maintain a positive outlook on sales growth. Despite the challenges, the robust service segment and global pricing keep OTIS positioned for the future. Management’s guidance aligns with my expectations, forecasting 2023 net sales of $14.0 to $14.3 billion, representing a growth of approximately 3% compared to the 4.3% decline in 2022, indicating confidence in the company’s outlook. Risks & Conclusion A notable downside risk for the company lies in the downward trend of NE orders, particularly the sharp decline this quarter. Coupled with downward revisions in the market outlook for key regions, there is potential for a substantial impact on revenue and profitability. Of particular concern is the anticipated high-single-digit market decline in EMEA and the Americas, along with China’s revised market contraction, which could have significant consequences. While the resilience of the services segment provides some cushion, the projected slowdown in organic growth in the latter half of 2023 presents a challenge. Additionally, dependence on the Asia Pacific, primarily India, for sustained growth could be precarious in the face of unforeseen market disruptions. The adjustments in China’s pricing due to market difficulties further underscore potential vulnerabilities. In summary, this quarter witnessed a notable surge in NE sales, juxtaposed with a decline in NE orders compared to the same period last year, leading to management’s downward revision of market expectations for most major regions, except for the Asia Pacific, buoyed primarily by India’s performance. EMEA, especially Northern Europe, faces challenges, as does the Americas, primarily due to shifts in the multifamily residential sector. Furthermore, China’s market outlook has turned more pessimistic. Despite the challenges, the robust growth in services, along with modernization efforts and increasing global pricing, offers a counterpoint to these concerns. While challenges persist, the company maintains a generally optimistic outlook on future organic sales growth. Management’s guidance for the coming year reflects a degree of confidence, suggesting resilience in the face of evolving market dynamics. Given the lack of margin of safety and the formidable challenges in NE orders, I recommend a hold rating. You Might Be Interested In 3 Stocks to Buy No Matter Which Way Inflation Moves New Jersey Devils, Prudential Center, and Verizon Extend Partnership Snowflake Crowned as Market’s Hottest Stock, According to Jim Cramer OCBC Facilitates SGD 16 Million Sustainability-Linked Loan to Ghim Li Through ESGpedia Platform UBS Initiates Sale of Additional Tier 1 Bonds Following Credit Suisse Controversy Microsoft Set to Unveil New AI-Enabled Devices
