Otis Worldwide: Boring can be good.

Most people may not find the elevator and escalator industry very exciting, which may lead to investors staying away from investing in Otis Worldwide. However, it may be a mistake as Otis Worldwide provides recurring revenue, which is one of the reasons why Terry Smith from Fundsmith has included Otis Worldwide in his portfolio. In this analysis, I will investigate whether Otis Worldwide should be added to my portfolio.

This is not a financial advice. I am not a financial advisor and I only do these posts to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.

This analysis will be a bit different from what you are used to reading in my blog. Otis Worldwide conducted their IPO in April 2020, which means that I do not have access to historical data prior to that date. I will still calculate a buying price using the principles I have learned from my Phil Town workshop, as Otis Worldwide is not considered a growth company. Since I cannot find the historical numbers, I will combine the principles from the Phil Town workshop, with the principles I have learned from the GOAT academy. Hence, this analysis will be a bit different than my other analyses. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to easily get the numbers you need from various companies.

Before I begin the analysis, I should mention that I do not currently own any shares in Otis Worldwide. However, I do own shares in one of their competitors, Kone Oyj, which represents a small position (2% of the portfolio). If you would like to view or copy my portfolio, you can find instructions on how to access it here. As always, I will keep this analysis unbiased despite owning shares in one of their competitors. If you want to purchase shares or fractional shares in Otis, you can do so through eToro. eToro is very user-friendly and easy to get started with. You can start with as little as $50. Click on the picture below to get started

Otis Worldwide is the world's leading elevator and escalator manufacturing, installation, and service company, serving customers in over 200 countries worldwide. Otis Worldwide was founded in 1853. It was acquired by United Technologies in 1976 and later spun off in 2020 when it conducted its IPO. They operate in two different segments: New Equipment and Services. The New Equipment segment is where Otis Worldwide designs, manufactures, sells, and installs elevators, escalators, and moving walkways. The Service segment is where Otis Worldwide provides maintenance and repair services, as well as modernization services, to upgrade elevators and escalators. This includes their own equipment as well as equipment from other companies. In 2023, New Equipment contributed 41% of net sales, while Services contributed 59% of net sales. When examining operating profit, New Equipment contributed 16%, while Service contributed 84%. Hence, the service segment is by far the most profitable. Otis Worldwide is the largest company in the industry and has been in existence for 169 years. It continues to win projects based on its innovation, ability to deliver, and the trust the customers have in the company. Thus, I believe that it is safe to say that Otis Worldwide has built a strong moat that its customers trust.

The CEO is Judy Marks. She first joined Otis Worldwide in 2017 and has been the CEO since the spinoff in 2020. Prior to joining Otis Worldwide, she held various positions at IBM, Lockheed Martin, and Siemens AG. She has a degree in electrical engineering from Lehigh University. She wants to grow Otis Worldwide by transforming and disrupting the company. As she says, "That's part of the culture of reinventing in a company that happens to be number one in our market now, but we can't rest." One way to reinvent and disrupt Otis Worldwide is by leveraging new technologies, such as artificial intelligence, automation, and robotics. These technologies can be utilized for high-volume repetitive tasks, a concept that Judy Marks has discussed. As a leader, she believes that culture plays a crucial role in any organization. Culture is a significant aspect of her leadership style, emphasizing empowerment and respect as crucial elements. In an interview, she mentioned that you cannot have a successful business if you don't have satisfied customers and engaged colleagues, regardless of the size and scale of the business. According to Comparably, she has an employee rating of 76/100, which places her in the top 15% of similarly sized companies. It is still too early to judge Judy Marks as a CEO, but I personally appreciate her desire to innovate and transform the company, while also emphasizing the significance of contented customers and motivated employees.

I believe that Otis Worldwide has a strong moat. I feel confident in management, but there are still some uncertainties due to the relatively short time the CEO has been leading the company. Later, I will calculate the purchase price for Otis Worldwide. Before I do that, let's examine some key numbers.

The first metric we will investigate is the return on invested capital (ROIC). I would like a 10-year history demonstrating a minimum annual growth of 10%. Otis Worldwide made its IPO in 2020, so we only have four years of history. In the four years that we have data, Otis Worldwide has delivered impressive results, with Return on Invested Capital (ROIC) exceeding 60% in three out of the four years. In the only year when Otis Worldwide did not achieve a ROIC above 60%, they still managed to deliver a ROIC above 34%, a figure that most companies fail to attain. I believe that these numbers are exceptionally good. If Otis Worldwide can continue to deliver such high numbers in the future, it indicates that Otis Worldwide could be a compounder for long-term investors.

The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. It is a bit surprising that the numbers are negative in all years. Many companies have taken advantage of the low interest rate environment to utilize inexpensive debt for share buybacks. I haven't been able to find out if that is the case for Otis Worldwide as well, but I suspect it is, considering Otis Worldwide is a highly profitable company. Therefore, I wouldn't place too much importance on these numbers for now.

Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising that Otis Worldwide has consistently generated a positive free cash flow in all four years for which we have data. Free cash flow has decreased slightly since its peak in 2021 but increased from 2022 to 2023, which is a positive trend. Levered free cash flow yield has decreased slightly from its high in 2021 and continued to decrease slightly in 2023. I would like to see the levered free cash flow yield increase again in 2024. Free cash flow yield has been at the same level in 2022 and 2023, and lower than in the previous years. This indicates that the shares are trading at higher valuations than in the first two years. However, we will delve deeper into this aspect later in the analysis.

Another important aspect to consider is the level of debt. It is crucial to determine if a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After analyzing Otis Worldwide's financials, I found that the company has 4,88 years' worth of earnings in debt. It is higher than I would like to see, but lower than it was in 2020 and 2021. The explanation for the high debt is that there are indications that Otis Worldwide has used cheap debt to repurchase shares, while it has also made acquisitions. Thus, while I don't like to see high debt, it doesn't deter me from investing in Otis Worldwide.

Before we proceed with the calculations, I would like to assess the risks and potential of Otis Worldwide. One risk is macroeconomics. In their annual report, Otis Worldwide mentions that their business, operating results, and cash flows may be adversely affected by changes in global economic conditions and geopolitical risks. These risks include global credit conditions, levels of consumer and business confidence, commodity prices, raw material and energy costs, supply chain issues, foreign currency exchange rates, interest rates, labor costs, levels of government spending and deficits, trade policies, tariffs, and trade barriers, political conditions (including those related to the results of the 2024 election in the U.S. or otherwise), regulatory changes, and fluctuations in residential and commercial construction activity. These economic and political conditions affect Otis Worldwide in various ways. A slowdown in building and remodeling activity, decreased public spending on infrastructure projects, or reduced spending on commercial real estate could negatively impact Otis Worldwide's financial performance. Competition. Otis Worldwide operates in a global and highly competitive industry. Due to the global and localized nature of the industry, there are numerous participants of varying sizes operating within it. According to industry estimates, there are hundreds of participants that offer new equipment solutions and several thousand participants that offer maintenance and service solutions. In both the New Equipment and Service segments, major competitors globally include KONE Oyj, Schindler Group, and TK Elevator, while there are a number of additional competitors in the Asia Pacific region. Compliance with government regulations. Otis Worldwide operates in a highly regulated industry. Any changes in legislation or government policies could impact the industry. Changes in employee safety, labor-related regulations, industrial equipment, licensing requirements, foreign ownership limitations, and building and elevator safety codes can affect Otis Worldwide's operations. In addition, their operations are subject to and affected by environmental regulations promulgated by federal, state, and local authorities in the United States, as well as regulatory authorities with jurisdiction over their foreign operations. Otis Worldwide has incurred and will likely continue to incur liabilities under various government statutes and regulations for the cleanup of pollutants previously released into the environment. Possible liabilities in the future could significantly impact their competitive position, cash flows, results of operations, or financial condition.

There are also potential opportunities for Otis Worldwide moving forward. The maintenance and repair services are growing. The organic sales of high-margin maintenance and repair services have grown every year since its IPO, and management expects that the organic sales will continue to grow by 5,5% to 6,5% in 2024, driven by significant additions to their maintenance portfolio. Otis Worldwide has also managed to grow its margins in these services despite the macroeconomic headwinds and has improved them every year since its IPO. Hence, Otis Worldwide is expanding its highest-margin segment and improving its margins within that segment. It is something fantastic for shareholders and could qualify Otis Worldwide as a compounder to buy and hold, if this trend continues. Modernization. The other part of Otis Worldwide's service segment is modernization services. Otis Worldwide continues to expand its modernization services, with orders increasing by 16,8% in 2023. Management anticipates that orders will continue to grow in all markets in 2024. Management has mentioned that refurbishment is required due to the aging equipment that is outdated based on construction cycles from over 20 years ago. It means that Otis Worldwide is currently in a natural growth cycle, where modernization orders will continue to increase. Modernization margins are not as high as those for maintenance and repair services, but management expects that they will continue to increase moving forward. Urbanization. Management mentioned that as urbanization continues, the demand for their products and services has never been greater. According to The World Bank, the trend of urbanization will continue to progress. The World Bank expects the urban population to more than double from its current size by 2050. By that point, nearly 7 out of 10 people will live in cities. This means that most cities will need to construct taller buildings, resulting in an increased demand for elevators and escalators. Consequently, these new elevators will also require maintenance, servicing, and eventually modernization.

Now it is time to calculate the share price of Otis Worldwide. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 3,39, which is from the year 2023. I have selected a projected future EPS growth rate of 8%. Finbox expects EPS to grow by 8,4% in the next five years. Additionally, I have selected a projected future P/E ratio of 16, which is double the growth rate. This decision is based on Otis Worldwide's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $28,95. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Otis Worldwide at a price of $14,48(or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 1.627, and capital expenditures were 138. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 97 in our calculations. The tax provision was 533. We have 406,6 outstanding shares. Hence, the calculation will be as follows: (1.627 – 97 + 533) / 406,6 x 10 = $50,74 in Ten Cap price.

The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Otis Worldwide's free cash flow per share at $3,64 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is $41,81.

After investigating Otis Worldwide, I find the company to be very interesting. I believe they have a decent competitive advantage, or "moat," and I have confidence in management. Otis Worldwide may face some short-term challenges due to macroeconomic factors, but the macroeconomic conditions are expected to improve in the long run. Competition poses a risk for Otis, especially in the high-margin service segment where they compete with thousands of participants worldwide. However, Otis Worldwide has managed to continue growing its service segment since its IPO, indicating that customers value the services that Otis Worldwide offers. Complying with government regulations will always pose a risk, and Otis Worldwide is likely to continue incurring liabilities in the future due to environmental regulations. However, these are expected, and I don't believe that they should deter someone from investing in Otis Worldwide. Otis Worldwide continues to expand its highly profitable maintenance and repair services. As the installed base grows, Otis Worldwide has a significant opportunity to further develop these services. Otis Worldwide is currently in a natural growth cycle in modernization, and this segment continues to grow year over year. Otis Worldwide has now experienced six consecutive quarters of orders up over 10%. Modernization still has low margins, but management expects these to increase, which will make Otis Worldwide more profitable. Finally, Otis Worldwide will also benefit from the urbanization trend, as there are currently no alternatives to elevators and escalators. I like the company and the industry. I plan to buy shares in Otis Worldwide if the price falls below $80, as this is lower than the intrinsic value based on two out of three of my calculations.

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