Don’t you just love the British summer? Instead of shivering from the cold, as we do for most of the year, we get to swelter from the heat for a week or two.
These high temperatures are good news for at least one group of people: air conditioning manufacturers are seeing a surge in sales.
Some of this is a one-off, of course. But there are signs that – after a dismal few years – the air-conditioning and heating industries are finally seeing business improve around the world.
Global sales are expected to rise at an annual rate of around 6% over the next few years, according to market research firm Lucintel. The wider heating, ventilation and air-conditioning sector is expected to grow to a value of $95bn in five years’ time.
So what’s driving this? And how can you profit from it?
Why keeping cool matters for economic development
One big driver of demand for air-conditioning is the growing global middle-class. The precise definition of what constitutes ‘middle-income’ is subjective, of course. The Brookings Institution estimates there are two billion people in this category worldwide, while the Carnegie Endowment, using a broader definition, thinks it could be as high as four billion.
Whatever the number, it’s clear that it’s growing at a rapid pace. And if there’s one thing that the middle-classes in hot countries want, it’s air-conditioning.
Unlike their parents, these newly affluent consumers are unwilling to put up with extremes of heat. This means that in countries with long, hot summers, air-conditioning is becoming mainstream – not unlike central heating over here in the UK.
Already, half the market for air conditioning comes from Asia. In China, 70% of homes now have some sort of cooling system, up from 4% less than ten years ago. And in India, despite a dodgy power network and large price hikes, sales of air conditioning units have gone up by 23% this year alone.
Yet there is still plenty of potential for expansion. Even in big Indian cities such as Mumbai, only 20% of houses have some sort of air conditioning.
But there’s a lot more to air conditioning than keeping people comfortable in their homes. It also plays a vital role in helping hot countries stay economically competitive.
Various studies show that when the temperature in an office rises above a certain level – 80°F/27°C seems to be key – people become much less productive.
One powerful example of the importance of keeping workers cool comes from Japan. Due to the impact of the Fukushima disaster on the power network, the government has ‘encouraged’ firms to cut back on cooling to save energy, only turning on air conditioning above 85°F/29°C. However, there are now complaints that workers are becoming visibly tired towards the end of the day, with some suffering headaches and even fainting.
Even if office workers are happy to put up with the heat, there’s the problem of office equipment. Computers suffer worse performance and shorter lifespans when faced with prolonged heat. Some servers and sensitive equipment won’t work at all.
At the same time, the fast-paced nature of the global economy means that traditional methods of dealing with the heat, such as siestas in the middle of the day, are simply not practical.
Since firms are becoming ever more data driven, and most economic growth is set to be in hotter emerging markets, it’s hard to see how this can’t be good for the air-conditioning business.
The US housing recovery is boosting demand
While demand from emerging economies is clearly important, it’s not the whole story. At the moment, the US forms around half of the global air conditioning market. And the last few years have been bad for business. Sales remain below their pre-crisis peaks.
The housing market collapse led to a dramatic fall in the number of new homes built. With fewer homes being built, there was much less need for new air-conditioning systems. Demand has also been limited by the fact that the market has reached saturation point – virtually all American households have some sort of heating and cooling system, and most have air conditioning.
However, the market is picking back up. With house prices starting to increase and the backlog of unsold homes beginning to clear, the construction industry is coming out of hibernation. More homes means more air conditioning systems.
At the same time there is a great push to replace older systems with more energy-efficient models, with the US offering tax credits on newer systems.
So how can you profit from all this?
The industry is fragmented, with a large number of small private firms at one end and several subsidiaries of larger electronics conglomerates at the other.
The best ‘pure play’ on the industry is German-listed Daikin Industries (GERMANY:DKI). Daikin is the second-largest maker of air conditioners in the world. Due to its award-winning technology, it has a large share of the Asian market. Thanks to its ownership of Goodman Global it also has a strong position in the US.
Daikin currently trades at 24 times trailing earnings. However, recovery in the Japanese air-conditioning market as restrictions on energy usage ease, and general growth in emerging markets should ensure that sales rise by nearly 50% in the next three years. This means that by 2016 it will trade at 14 times earnings, with excellent future growth prospects.
See our recent magazine cover story for more on air-conditioning and how to profit from energy efficiency. If you’re not already a subscriber, you can subscribe to MoneyWeek magazine.
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