Although its shares have advanced roughly 11% over the last month, the elevator company Otis Worldwide (PRINT -0.23%) reported mixed results for its second quarter. Headline sales and profits were OK, but after adjusting for currency, they appeared positive. However, a deeper look reveals why management lowered its guidance for the year. Here’s what happened.
Smooth ride, for now
Last week, Otis reported its second-quarter earnings financial results. On the surface, the company had a mundane quarter. Net sales were down 5.8%, and earnings per share under generally accepted accounting principles (GAAP) were flat. Management blamed Chinese lockdowns and a strengthening US dollar for its woes. However, some bright spots lie below the surface.
Otis had record new equipment orders and its maintenance portfolio units were up 3.5%. After the company accounted for one-time items, adjusted earnings per share were up 11.7%. The company also repurchased $200 million of its stock.
Otis’ elevator business comprises two main parts. First, the company sells new elevators and equipment to real estate developers as they construct new buildings. The elevator is the lifeblood of any commercial or residential building. It gets things to where they need to be and people to their homes. So it is essential to have a reliable elevator.
As interest rates rise across the globe, real estate markets have shown signs of slowing down, especially in China. During the quarter, Otis’ organic sales were down 4.2% in the Americas; down 2.7% in Europe, the Middle East, and Africa; and down by a low-teens percentage in China. Severe issues in China’s residential real estate market are well documented. Property sales in China are on pace to fall more than they did during the 2008 financial crisis.
After considering these issues, Otis management decreased its organic sales outlook for new equipment for the full year 2022 from flat. The new guidance is for sales up 1.5% to down between 0.5% and 1%. The company’s organic sales outlook for the Americas was lowered from up by a low-single-digit percentage to flat. Organic new equipment sales outlook in Asia decreased from down slightly to down low single digits.
Otis’ second and most profitable business comes from repair, upgrade, and modernization services to its maintenance portfolio. If you’ve ever been stuck in an elevator or been surprised by an “out of order” sign by the elevator in your condo or apartment building, you know how frustrating it can be. Property managers are fully aware of potential tenant concerns. Therefore, elevator repairs and preventive maintenance are critical.
Although new equipment sales are expected to decline, service revenue is not. During the second quarter, management revised its 2022 organic service revenue for maintenance and repair from up between 5% and 6% to up between 5.5% and 6%. Organic modernization revenue is now expected to be up between 6% and 9%. Previous guidance was for a 5% to 6% gain.
Otis is a high-quality, profitable company. For instance, sales and profits from its growing maintenance portfolio come from long-term contracts with customers. Those customers are eager to sign contracts because they understand the importance of running their elevators smoothly. At the same time, it’s hard to ignore the issues in the Chinese real estate market, which is Otis’ largest market for new equipment sales.
Although shares are up 11% in the last month, they’re down around 9% for the year. And although the company’s second-quarter adjusted earnings per share of $0.86 beat Wall Street estimates of $0.78, investors should be comfortable accepting the near-term risk in the China market before diving in.
BJ Cook has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.