Mix together adverse weather, a pandemic and a gloomy forecast for 2020 and you have the ingredients for an undervalued stock. This is its year-to-date chart:
But Lennox International Inc. (LII, Financial) is also a predictable stock; it gets a full five out of five from GuruFocus for consistently improving its bottom line. Will it return to glory once the current health and economic crisis passes?
According to its 10-K for 2019, the company designs, manufactures and markets products that move air around your home and elsewhere; “heating, ventilation, air conditioning and refrigeration (“HVACR”) markets.” It operates in the residential, commercial and refrigeration markets, with 60% of its revenue coming from residential.
And that was part of the problem, as noted in the April 20 press release that provided details about the first quarter of 2020. Because of warmer weather and Covid-19, residential work was down, contractors were reducing their inventory and national accounts were pushing their orders out into the future.
That meant revenue, operating income and earnings were all down. On a per-share basis, earnings from continuing operations dropped from 86 per share in first-quarter 2019 to 32 cents this year (after adjusting for an 87 cents per share insurance benefit; tornado damage to a plant in Iowa).
To make matters worse, the company’s guidance for this year included industry shrinkage of 20%, and that its earnings per share from continuing operations would drop from a range of $11.30 to $11.90 to a range of $7.07 to $8.07. It’s no surprise, then, that the company’s stock has been pummelled.
Yet, as noted, Lennox is a company that has an excellent history. Shareholders who bought in the wake of the 2008 financial crisis and held until recently would have enjoyed what Peter Lynch called a “10-bagger”, a share price that increased tenfold. Of course, much of that has been erased in the last couple of months.
To investigate that strength, we will assess the company with the Macpherson model, the screen that GuruFocus writer and Nintai Investments fund manager Thomas Macpherson uses to initially screen prospective buys.
Moat
The first test in the model is for a moat, a competitive advantage that allows a company to sustain its premium pricing and above-average profitability. It uses two criteria:
- A 10-year median return on capital of at least 15%. The lowest ROC in the past decade was 15.72 and for 2019 it was 39.63, so Lennox has no trouble in getting over this hurdle.
- A 10-year median return on tangible equity of at least 15%. However, Lennox shows negative tangible equity.
Financial strength
The table below shows that Lennox meets neither of the financial strength criteria: a cash-to-debt ratio of at least 100 and a financial strength rating of at least 9:
A big part of that miss on financial strength is due to growing short- and long-term debt plus capital lease obligations in the past couple of years:
Of the total $980 million in long-term debt and capital lease obligations, the debt portion was $823 million. That’s up more than four times from $217 million in 2013. Over the same six years, total long-term assets only grew from $724 million to $914 million.
On the other hand, Lennox had $473 million in accounts receivable and $43 million in cash and marketable securities at the end of 2019.
Profitability
The other table shown above backs up the claim that Lennox has been a profitable enterprise in past years. It has a 9 out of 10 rating, double-digit margins and revenue and earnings per share growth, although the growth of revenue has been slower.
Valuation
Finally, on the model’s list of tests is an appropriate valuation. To check it, we use the GuruFocus discounted cash flow calculator, based on earnings (as recommended).
The “fair” or intrinsic value of Lennox shares is $255.93, well above the current price of $170.72. It provides a 33.29% margin of safety, keeping in mind that the future value and the size of the margin are simply conceptual rather than real forecasts.
Overall, the Macpherson model suggests a weak pass for Lennox. The company has a strong return on capital, indicating the existence of a moat, its financial strength is moderate, it is highly profitable and it is selling at a 33% discount to its intrinsic value.
Ownership
The message is mixed when it comes to buy and sell transactions among the investing gurus followed by GuruFocus:
Of the seven gurus who had holdings at the end of last year, only Steven Cohen of Point72 Asset Management had more than 100,000 shares (he held 296,000). The three with between 10,000 and 100,000 each were Pioneer Investments (Trades, Portfolio), Louis Moore Bacon (Trades, Portfolio) of Moore Capital Management and Ray Dalio (Trades, Portfolio) of Bridgewater Associates.
Covid-19 response
In its press release with first-quarter results, the company announced:
“Lennox has a focused and seasoned team with experience managing through economic downturns. We have already taken cost reduction actions to realize $115 million in SG&A savings for the balance of the year. We expect cash generation this year to remain strong as working capital requirements shrink and we take action to reduce our capital expenditures. While executing on what is required in current economic conditions, we remain mindful of the future and are confident we will once again strengthen our position in the market as we emerge in the recovery.”
Conclusion
With a tenfold increase in its share price between the 2008 financial crisis and 2019, as well as a five of five rating on financial predictability, Lennox seems like an easy choice for investors with cash in their pockets. However, this is a company that also increased its debt significantly in the past two years.
The messages from our quantitative and qualitative analyses are mixed currently, so this stock seems more suited to watching than buying.
Lennox International may suit aggressive investors looking for companies with good prospects on the other side of the current crises, but value investors will likely want to sit on their hands for now.
Disclosure: This article is only an introduction to the company and investors must do their own due diligence. I do not own shares in it and do not expect to buy any in the next 72 hours.
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