EUR 850.00 For Business Accounts Only

Morningstar | Damaged Manufacturing Facility Will Damp Lennox's Near-Term Growth; Long-Term Outlook Unchanged

Over the past several years, Lennox has capitalized on its efforts to gain market share and cut costs amid a backdrop of improving end-market demand. The company’s margin expansion story has been remarkable, with adjusted operating margins expanding from about 8% during the last sales peak in 2007 to over 13% in 2017. We think its expanding distribution network and product portfolio have helped Lennox gain market share, while low-cost Mexican manufacturing, Asian product sourcing, and more cost-efficient product designs have helped the company reduce its cost base. Lennox-branded products are distributed through a company-owned distribution network, which we see as an advantage because Lennox has more control over sales strategy, marketing efforts, and dealer training and support. Lennox’s PartsPlus store strategy has expanded the company’s distribution network and improved product availability and fulfillment rates. In terms of new products, Lennox has entered the variable refrigerant flow market and introduced the Raider emergency replacement product line to go head-to-head with Carrier. Overall, we believe a growing PartsPlus store footprint and product portfolio will help the firm better penetrate dealers and gain market share. We remain bullish on the longer-term outlook for residential construction, which bodes well for Lennox because the firm generates about 56% of its sales and 62% of its profits from its residential HVAC business. We also expect the firm’s residential HVAC business to benefit from a robust replacement cycle to address aging HVAC units purchased during the last housing boom. Now that much of the cost-reduction-related heavy lifting is complete, we expect future margin expansion will come more from volume-driven operating leverage and favorable mix shift than self-help measures, although opportunities still exist to improve the refrigeration business. Still, we think Lennox’s margins are likely to peak by 2020 as volume and mix-shift-related tailwinds abate and the firm encounters potential headwinds from competition and rising commodity costs.