As the summer heat intensifies, so does the demand for air conditioning solutions. However, investors should exercise caution to avoid potential pitfalls.
Over the weekend, ERCOT, the entity managing Texas’ electricity grid, issued a weather warning in anticipation of soaring temperatures and increased electrical demand. This surge in demand for electricity is expected to strain reserves.
The scorching temperatures have led to a substantial increase in the use of air conditioning units. On July 13, Texas set an unofficial July and all-time peak demand record, reaching a staggering 81,406 megawatts. The significance of this record cannot be overstated.
Unsurprisingly, air conditioning stocks have been riding high on this wave of increased demand. Worries about potential power outages have fueled consumer interest in upgrading and repairing their AC systems.
Leading heating, ventilation, and air conditioning providers, including Carrier (CARR), Trane Technologies (TT), Lennox International (LII), and Johnson Controls (JCI), all reached their 52-week highs on Monday. Meanwhile, backup power provider Generac (GNRC) has also experienced substantial growth.
Since the end of May, these four stocks, along with shares of Generac, have seen an average increase of 22%, significantly outperforming the broader market. In comparison, the S&P 500 has gained approximately 5% during the same period, while the Nasdaq Composite has managed a modest 7% growth.
Interestingly, despite the soaring stock prices, earnings estimates for these five companies have remained relatively stable throughout the summer. It appears that investors are willing to pay higher valuation multiples, with the group’s average PE ratio now standing at almost 22 times estimated 2023 earnings, up from around 18 times when summer began.
While the heatwave has undoubtedly brought good fortune to air conditioning stocks, investors should proceed with caution. As temperatures continue to rise, the long-term sustainability of this upward trend remains uncertain.
Caution for Investors Ahead of Earnings: HVAC and Generator Stocks Face Risks
As the earnings season approaches, investors in the HVAC and generator industries may need to exercise caution. Four key players in the HVAC sector have provided bottom-line EPS guidance for 2023, and considering the current trading patterns of their stocks, investors will likely expect an upward trend. Meanwhile, Generac, a leading generator manufacturer, has provided sales growth guidance for the same year. Investors will be keen to see an increase in its estimated 2023 sales figures.
Perhaps it is the experience with Generac that makes us somewhat nervous. Our recommendation coincided with the 2022 hurricane season, during which Generac stock typically experiences a rally if there are many storms. In hindsight, we should have paid closer attention to channel inventories. It appears that excessive inventory at dealers led to guidance cuts by the generator maker.
Despite these concerns, both the HVAC and generator businesses have solid fundamentals and a promising long-term outlook. The stocks may continue to perform well, but it is advisable to approach the upcoming second-quarter earnings reports with caution.
Timing the stock market accurately is notoriously difficult. We are not suggesting drastic changes to anyone’s investment strategy or portfolio. However, we emphasize the importance of monitoring weather conditions. This way, investors can avoid being caught off guard and suffering potential losses after earnings are reported.