As I've suggested before, the other side of the energy-shortage trade is energy conservation. Unlike speculating on alternative energy technology, the energy conservation technology and products are well developed and, when implemented, will immediately reduce energy consumption. The U.S. Department of Energy’s Office of Energy Efficiency and Renewable Energy [EERE] estimates that buildings are responsible for 70% of electricity demand and 50% of natural gas demand. Likewise, the EERE estimates that heating and cooling account for 56% of energy use in a typical home in the U.S. Four large-cap stocks with varying degrees of exposure to the energy efficiency business are American Standard (ASD), Johnson Controls (NYSE:JCI), Honeywell (NYSE:HON), and United Technologies (NYSE:UTX).
As part of the infrastructure boom, the energy efficiency business benefits from significant construction activities around the world as well as the need to replace failing equipment in developed countries. The EERE estimates that by 2015, 15 million buildings will be constructed in the U.S.. All of these new buildings will need the HVAC (heating, ventilation, and air conditioning) equipment and services these companies provide as well as the sensors and controls for energy efficiency.
On May 17th, 2007, Johnson Controls released the results of the Energy Efficiency Indicator Research survey:
Overall, the executives’ outlook on energy prices is pessimistic, with 79 percent expecting prices to increase significantly over the next 12 months. The average increase expected is 13.25 percent. This expectation appears to have fueled a greater interest in energy efficiency, with more than 60 percent saying their companies are paying more attention to energy efficiency today than five years ago; and about 60 percent saying they plan to make investments in energy efficiency with operating budgets and 60 percent with capital budgets. (Almost 50 percent say they plan to tap both operating and capital budgets for energy efficiency improvements.) Moreover, of the companies building or planning to build new facilities or launching retrofits in the near future, three quarters say that energy efficiency will be a priority in the design of those projects.
The commitment of capital to upgrade building systems have been slow, “Little more than one third (36 percent) have negotiated energy contracts with suppliers, a seemingly obvious step to take. Only 13 percent have re-roofed with white shingles to reduce heat gain; 11 percent are capturing waste energy generated by operations; and 8 percent have converted to using alternative fuels.” The predominant method of energy conservation, educating employees to turn off lights and conserve energy, has been shown to have no effect as energy conservation is usually not the first thing on employees’ minds. I believe business owners will have to upgrade sooner or later, whether if its due to higher energy costs or the breakdown of equipment. My confidence in the energy efficiency business is confirmed by American Standard’s company breakup. American Standard will only retain its its global air conditioning system business and renamed Trane, its leading air conditioning system brand.
Trane - American Standard after breakup
I will be looking to buy American Standard under the name Trane after the company separates. If you buy Trane, you will have a pure play on the HVAC business where heating and cooling, as mentioned before, accounts for some 56% of energy use by U.S. homes. The business provides a full range of commercial and residential equipment, advanced building controls, parts, and installation and maintenance services for energy-efficient heating, ventilation, air conditioning [HVAC] and indoor air quality. Trane products operate in more than half of all commercial buildings in North America including office buildings, hotels, hospitals, schools and high-tech manufacturing plants. Trane’s HVAC hardware such as chillers, the big tanks of refrigerant that cools the air, is probably the best quality in the industry. With 73% of sales in the U.S. and only 10% in Asia, Trane has a lot of potential for growth in Asia as cities start popping out of the ground and needing HVAC systems.
ASD 1-yr chart
Johnson Controls’ building efficiency business accounts for 32% of revenues in 2006, while automotive experience accounts for 57% and power solutions accounting for 11%. The building efficiency business engineers, manufactures and installs control systems to automate a building’s heating, ventilating and air conditioning, as well as its lighting and fire safety equipment. The control systems operate the building “by wire”, where the monitoring network of sensors and computers constantly tweak a building’s mechanical operation such as air conditioners or furnaces for minimal energy usage while achieving the necessary conditions inside the building. As sensors and computers have improved, such operating “by wire” can offer significant energy reductions and improved performance by instantly reacting to environmental or operational changes. Like driving a car, it is better to have a smooth ride than starting and stopping which uses much more energy and wears down the equipment. As a side note, Johnson Controls’ automotive experience business makes such “drive by wire” technology. For instance, computers constantly monitor your tire’s pressure and adjusts your car’s mechanisms to operate accordingly. Thus, Johnson Control’s various business are actually quite similar and based on related technologies: control systems.
Last year, Johnson Controls acquired York, who provides industrial and residential HVAC hardware such as chillers and furnaces. York’s business is most similar to American Standard’s Trane business. I believe Johnson Controls’ will realize great synergies from the acquisition of York as Johnson Controls can now sell the HVAC hardware to go along with its control systems, rather than losing out on the HVAC hardware part of a contract to a HVAC hardware provider.
JCI 1-yr chart
Known as an aerospace conglomerate, Honeywell actually has a substantial automation and controls business that accounts for 35% of sales. Within this business segment are building efficiency products similar to Johnson Controls. Honeywell’s control systems helps improve energy efficiency, life safety, climate control, air quality and productivity in homes, buildings, industrial sites, and government facilities. It also has sensor products to improve performance and adaptive capabilities for buildings, medical, automotive, aviation, technology, and consumer appliances. Since Honeywell provides the control systems for “fly by wire” fighter jets such as the new Joint Strike Fighter by Lockheed Martin (NYSE:LMT), it follows that Honeywell’s control systems for other applications wouldn’t be too shabby either. Honeywell is more diversified than Johnson Controls or American Standard’s Trane. Honeywell should be a core portfolio holding based solely on the strong aerospace and defense cycle, but its controls systems business is still significant and should get a strong boost as the housing and auto industries start to improve.
HON 1-yr chart
United Technologies’ Carrier division represents 28% of revenues. Carrier should be a familiar household name for air conditioners. Carrier provides heating, ventilation, air conditioning, and refrigeration [HVACR] systems, components, controls and services. Carrier products are used in residential, commercial, industrial, and transporation applications as well as food service equipment. These businesses and technologies have all been discussed, so I won’t repeat them again. It should be noted that Carrier has a pretty strong presence in Asia, where there’s the most potential for growth. American investors often believe the rest of the world follows the U.S. as far as brands go. However, many European brands and stores have a stronger presence in Asia than American companies. So, be sure to check for market share in particular regions if part of your investment thesis involves the global growth story as I do.
UTX 1-yr chart
With the recession in housing and the weak auto sales, the strength of these companies and their stock price attests to the strength of management and operational success. Since these companies all have some exposure to the housing and auto sectors, these stocks should see much more upside once housing and autos start to recover. Meanwhile, the world is still growing and every new building needs the products and service of one or more of these companies.
Disclosure: I own shares of JCI as of this post. I have worked on a project for Honeywell before.