Otis: Soft Guidance and Further Deleveraging Makes Otis Unattractive

Otis released its Q4’21 and full year earnings on January 31st. Whilst revenue and profitability in 2021 was strong, Otis gave soft guidance for 2022 and the stock is down c.4% post results. This article will take a brief look at Otis’ performance in 2021 and what to expect for 2022.


Otis is an elevator and escalator installation, maintenance and service business. The business was founded in 1853, is headquartered in Connecticut, USA and is traded on the NYSE.


Otis, like other escalator companies, benefits not only from the sale of new elevator installations, but also ties customers into highly lucrative service contracts that provide a consistent operating cash flow profile.


Key Highlights From the Latest Earnings Report:


  • Good performance from Otis in full year 2021.

  • Soft outlook for 2022, with expected organic sales growth of 2.5% to 4.5% down from 8.9% organic growth in 2021.

  • Otis expects to face pressure in the first half of fiscal 2022, particularly in its New Equipment business segment, due to hard comparators and commodity headwinds. However, Otis expects that profit growth in its Service segment will offset these headwinds.


Overall Performance in Q4 and Full Year


In Q4, net sales were up 2.2% to $3.6 billion. Adjusted operating profit margin, at 14.6%, was flat versus the prior year. Across the quarter, higher volumes, productivity and favourable service pricing were partially offset by commodity inflation and the impact of COVID-19.


In its FY, Otis reported net sales of $14.3 billion, with organic sales growth of 8.9% from FY’20.


Segmental Performance


Otis’ business is divided into two key revenue streams, New Equipment (the installation of new elevators/escalators) and Service (the servicing of already installed equipment). Updates on the performance of each of these segments can be found below.


In New Equipment, net sales were up 2.0% in Q4. This result was mainly derived by sales in Otis’ Asia region, with sales up 11.9%. Sales were down in both its Americas region and its EMEA region by 9.5% and 6.3% respectively.


Sales growth in Asia is not expected to continue into 2022, with new equipment growth expectations expected to drop, as seen in the diagram below. Recovery is expected in both Americas and EMEA, up mid-high single digits and up low single-digits respectively.


The image shows the elevator maintenance and service industry's new equipment growth in 2021 and expected growth in 2022. In 2022, new equipment growth is expected to be in the mid-high single digits in the Americas, up low single digits in EMEA and down mid-high single digits in Asia.
Source: Otis' Q4 Earnings Report

In the FY, net sales for New Equipment were up by 19.7%, driven by Americas up 14.1% and Asia up 19.7%. Adjusted operating profit margin was 7.5%, up from 6.5% in 2020.


In Service, net sales were up 2.3% in Q4. Adjusted operating profit margin in the quarter was 23% due to a favourable price mix that was partially offset by higher field costs, including headwinds from Covid-19 recovery. In the FY, organic sales were up 4.1% and adjusted operating profit margin was 22.8%.


2022 Outlook


The chart in the image shows 2021 actual figures compared to 2022 outlook for Otis. Key takeaways from the chart are explained in the paragraph underneath the image.
Source: Otis' Q4 Earnings Report

In 2022, Otis expects organic sales growth of 2.5% to 4.5%, a reduction from 8.9% in 2021. Otis expects New Equipment to grow between 0.5% to 3.0% (down from 15.5% in 2021) and Service to grow between 4.0% and 6.0% (level or possible slight growth from 4.1% growth in 2021).


Otis expects to face pressure in the first half of fiscal 2022, particularly in its New Equipment business segment, due to hard comparators and commodity headwinds (Otis is expecting around $90 million in commodity headwinds). However, Otis expects that profit growth in its Service segment will offset these headwinds. New Equipment growth is expected to be stronger in the second half of 2022.


On the earnings call, management stated 2022 will have a slower growth rate than 2021, as 2021 was at a ‘much higher base’.


Otis will not release its medium-term outlook until its Investor Day on the 15th January, but the Group sees 2022 as a return to its ‘core Service growth [of around] 4-6%, which is supported by [its] portfolio growing 3%’.


In conclusion, Otis expects New Equipment to be a more volatile segment in terms of growth going forward, with its Service revenues sustaining the business.


Zardoya Otis Acquisition and Debt Profile


In December 2021, Otis finalised the deal to fully acquire Zardoya Otis, an elevator equipment and service business with operations in Spain, Portugal and Morocco, a company in which it already had a partial stake. Otis’ subsidiary, Opal Spanish Holdings, reached an agreement to purchase the remaining 49.99% of Zardoya Otis for €1.7 billion, with the Company's total valuation being €3.39 billion (US$3.83 billion). The deal is expected to close in Q2’22 and is an all-cash voluntary tender offer.


Otis took on 2 billion in extra long term debt in 2021 to buy Zardoya. In 2021, Otis’ Net Debt was 2.9x EBITDA after an initial $450 million debt repayment.


Given Otis’ current asset position is currently flattered by $1.6 billion of cash ‘restricted’ or set aside for the Zardoya Acquistion, I estimate Otis’ real net debt to EBITDA to be around 3.2-3.5x (after restricted cash has left the business) in 2022, the same rate it was in 2020. (Worth noting, this is much higher than analysts suggested in the earnings call).


Otis expects to cease buybacks in 2022 due to requirements in paying down debt. Once its ‘target leverage metrics are met’ the Group will ‘plan to recommence share repurchases’.


Summary


In summary, Otis delivered a solid year in 2021. However, weak guidance for 2022 and an extension to Otis’ leverage profile means the business will need to focus on delivering in 2022 (and potentially 2023) before returning capital to shareholders.


Otis’ reliable service revenues mean high leverage can be utilised for this type of business, although post spin-off from Raytheon, Otis already had a fair amount of debt on the balance sheet.


With soft guidance in 2022, a delay to the capital return and further deleveraging required I think Otis looks unattractive over the next 2-3 years.


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At the time of writing, James did not own shares in Otis.


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