Otis Worldwide: Long-Term Shareholder Value Is Still Headed To The Top Floor (NYSE:OTIS)

Thesis

Otis Worldwide Corporation (NYSE:OTIS) initially caught my attention because they have attractive margins and returns. This has allowed them to steadily buy shares off the open market while increasing their dividend. Their established reputation grants them sticky revenue and an attractive moat. I expect for them to be able to maintain their dividend growth over extended time frames. They have been in operation for over 170 years. After initially investigating the company 9 months ago, I have noticed that a majority of the elevators I use in my daily life were made by Otis.

This is a follow up to the article I wrote last April. After looking over their financials and valuation, I presently rate Otis as a Buy.

Company Background

Otis Worldwide Corporation is a provider of elevators, escalators, moving walkways and ancillary equipment and services. They were founded in 1853, and are named after Elisha Otis, who invented the safety elevator in 1852. The company was spun off from RTX Corporation (RTX) in 2020, and are currently headquartered in Farmington, Connecticut.

Industry-Wide Trends

The global Elevator and Escalator market is expected to experience a CAGR of 6.7% until 2029. The global Escalators and Moving Walkways market has a projected CAGR of 7.16% through 2030.

Guidance

Their most recent earnings call transcript can be found here, and the corresponding investor presentation can be found here.

The earnings call indicated that their third quarter was the 11th consecutive quarter of organic sales growth and the 15th quarter of operating margin expansion. In Q3 they secured contracts in British Columbia, Hong Kong SAR, Saudi Arabia, and China. The launch of their Gen 3 offering in Q2 has already generated sales in Q3.

They had a strong Q3. Overall, their financial situation appears to be steadily improving.

They are adjusting their guidance upward and now expected to achieve around $14.1B in net sales and roughly $2.265B adjusted operating profit. Their new guidance for EPS is $3.52; this is up 11%. For the full fiscal 2023, they now expect to have about $1.5B in free cash flow, and to buy back roughly $800M worth of shares.

Quarterly Financials

Their quarterly financials are showing that their revenue is fairly stable. They are already a fully mature stalwart and maintain a dominant market share, so I expect for their long-term revenue growth to roughly match global economic growth. If the macro trends around the construction of multistory buildings were to change, it could affect their future revenue either positively or negatively.

Eight quarters ago Otis had a quarterly revenue of $3,620M. Four quarters ago that had declined to $3,344M. By this most recent quarter that had grown to $3,523M. This represents a total two-year decline of 2.68% at an average quarterly rate of -0.33%.

Their gross margins have stayed fairly stable over the last ten quarters. Their EBITDA and operating margins experienced a contraction at the end of 2022, but have been slowly expanding since then. As of the most recent quarter gross margins were 29.95%, EBITDA margins were 18.11%, operating margins were 16.80%, and net margins were at 10.67%.

By repurchasing shares, they are making it easier to increase their dividend without having to increase revenue. This has the potential to produce attractive yield on cost for long term shareholders. The sum of their last eight quarters of buybacks has reduced the share count 3.71%. The sum of the last four quarters comes to 1.76%.

The most recent quarter, Otis had -$39M in net interest expense, total debt was at $7,700M, and long-term debt was at $6,822M.

As of the most recent earnings report, cash and equivalents were $1,636M, quarterly operating income was $592M, EBITDA was $638M, net income was $376M, unlevered free cash flow was $234M, and levered free cash flow was $209.6M. By dividing their long-term debt of $6,822M by their recent quarterly levered free cash flow of $209.6M, it appears they would need a little over 8 years to pay down their debt.

Their total equity is negative. Normally, I look for steadily rising equity, but when companies are able to safely maintain negative equity for extensive periods of time, it’s often a sign they are efficient. This is not unusual for asset-light companies with significant debt and recurring cash flow.

Their negative equity is handing them negative values for return on equity. I typically consider annual returns to be attractive if they are above 10%, and quarterly returns attractive if they are above 2.5%. So I consider these quarterly values for ROIC and ROCE to be very attractive. As of the most recent earnings report ROIC was 7.66%, ROCE was 6.22%, and ROE was -8.16%.

Otis currently has a payout ratio of 35.84%. They have been steadily increasing their dividend since being spun off.

Valuation

As of January 12th, 2024, Otis had a market capitalization of $35.28B and traded for $86.21 per share. Using their forward P/E of 25.45x, their EPS Long-Term CAGR of 10.50%, and their forward Yield of 1.58%, I calculated a PEGY of 2.107x and an Inverted PEGY of 0.4747x. Since fair value for PEGY values range from 1x to 1.5x, this produces a range for intrinsic value of $40.92 to $61.39 per share.

For the last 3 years, Otis has been trading with a P/E which ranges from 22x to 35x. It is currently trading with a P/E of about 26x.

When comparing their historic P/E ratio to the rest of the global elevator industry, Otis Worldwide typically trades below KONE Oyj (OTCPK:KNYJF) and Schindler Holding AG (OTC:SHLRF), but above Mitsubishi Electric Corporation (OTCPK:MIELY) and Thyssenkrupp AG (OTCPK:TKAMY). I do not put much faith in relative valuations since watching other investors lose a majority of the value of their investments during the Dot-Com crash. Many were buying companies merely because they were cheap when compared to their peers when the entire industry was overvalued. So it’s important to note that relative valuations do not indicate if a company is trading above or below its intrinsic value. Also, these companies all have different margins, returns, and cash flows, so this is not an apples to apples comparison.

Risks

Otis Worldwide has established itself as a leader in the elevator industry and currently controls 24.3% of global market share. While I believe it is unlikely that they will experience a degradation of their established reputation, it is always possible another competitor captures additional market share while Otis loses some.

They are a global company, so the risk of any individual country or region experiencing a significant recession is relatively low for Otis. While a regional decline is likely to affect their revenue somewhat, a global recession could present a major problem. The most obvious example I can cite right now is the significant economic decline that China has been experiencing. However, the recent maintenance contract they secured for the Pudong Airport indicates that consumers are still willing to pay for their services through troubled times.

Catalysts

The company stands to benefit from any future rises in the aggregate rates of construction of large buildings. This also implies that a lowering of interest rates and an increase in the velocity of money has the potential to provide them with revenue growth.

Conclusions

Otis Worldwide is a well-established leader in its industry. Their moat is established enough that some refer to them as a pseudo-monopoly. They have strong margins and consistently produce attractive returns.

Also, because they already have a solid reputation, spending money on advertising would be wasteful. This leaves them in a situation where if they don’t see an opportunity from expanding into a new segment, they have little else to do with their cash other than buy back shares and raise their dividend. I believe this should allow for them to continue raising their dividend. Overall, I consider Otis an attractive investment for long-term shareholders.

Getting Filled

Because of their significant moat and strong margins, instead of trying to time a bottom, I believe that anyone who is interested in establishing a long-term position in Otis should consider dollar cost averaging into an intentionally oversized position. This would allow for the potential of acquiring some of the shares at lows. At some point in the future the share price will rise and setting one’s brokerage software to sell the most expensive lots first should allow the investor to trim the excess position for a small gain while holding the cheapest shares for the long-term. This should help produce more attractive yield on cost.

For any of you who are familiar with options, it is also viable to attempt to get filled at attractive prices through a front put ratio spread. Instead of merely selling puts and hoping to get filled, I prefer to set up an asymmetrical spread because the long put helps push the break even on the trade lower. This strategy can be modified to use other expirations and other strikes. If all goes well, one will be able to get filled at both $70 and $75.

The way the trade is set up now, it immediately collects $28 in premium. It has a break even at $64.86. According to Optionsprofitcalculator.com these chosen strikes and expirations have a 99.5% probability of not losing money.

If the share price rises, the trade can be closed for a small gain. The zone of maximum profit at expiration is from $70 to $75. The profits begin diminishing as the share price falls below $70, and it starts losing money if the share price falls below $64.86. Again, the goal here is not to make significant profit from the trade, but to set up a low risk situation which has the potential to hand one shares at a lower price than it trades at today.