Lennox International

Lennox reported a 3% increase in revenue to $1.5 billion, 2% growth in operating profit to $355 million (30 basis points of margin compression to 23%), and flat earnings per share of $7.72 in its second quarter.

Why it matters: There was significant bifurcation in performance at Lennox’s two segments. Quite weak performance in residential was mostly offset by very strong performance in the light commercial-exposed business climate solutions segment. The company held its top-line guidance but reduced its EPS outlook by 3% at the midpoint. Revenue shrank 7% in home comfort solutions, and margin compressed 130 basis points to 23.7%. Management cited ongoing weak consumer demand and particularly weak exposure to residential new construction versus replacement. The second half should see volume growth on easier comparisons. The bright spot in the results was business climate solutions, which grew revenue 24% (12% organic) and realized 100 basis points of margin expansion to 25.5%. The company did particularly well with large national accounts and emergency replacements. Acquisitions also contributed.

Long view: We admit some surprise at management’s grim commentary on the status of the consumer and demand not really improving much until 2027. Competitor Carrier sounded a much more optimistic tone about an inflection point in residential HVAC demand.

The bottom line: We are decreasing our fair value estimate for narrow-moat Lennox to $560 per share from $563 on the revised guidance. Investors were clearly not pleased with Lennox’s commentary, sending the shares down 20% intraday on July 29 despite the minimal downgrade to earnings guidance. The share price reaction strikes us as overblown and likely offers an entry point for investment, though we will monitor whether there is more of an idiosyncratic issue here versus the peer group. We otherwise regard Lennox as a high-quality company.

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Our $560 fair value estimate equates to about 24 times 2026 earnings per share, which is reasonable in the historical context. Sales declined in 2025 due to weakness in the residential housing market and channel destocking. However, Lennox’s commercial business continued to deliver growth and margin expansion. Like most of its peers, management is guiding to accelerating top-line growth of 6%-7% and margin expansion driven by strong price/mix and M&A contribution.

We model a 9% revenue compound annual growth rate for the home comfort solutions business (residential) with gradual margin improvement to 23%, which is only 100 basis points ahead of current levels. We are reluctant to forecast much more margin expansion, despite the company’s likely growth trajectory, because it is already at the high end of the margin range it has historically guided for this segment. This could prove conservative as Lennox managed to deliver such high margins even when this segment posted meaningful revenue contraction.

For business climate solutions (light commercial), we model an approximate 10% revenue CAGR during our forecast horizon, which could prove conservative when benchmarked against the peer group. This figure is aided by acquisitions. Similar to the residential business, we only forecast 150 basis points of margin expansion to 25% based on similar logic that 25% is also modestly outside management’s guidance for the business. However, there has historically been a much more clear and consistent trajectory of margin expansion in this business.

With modest capital requirements of capital expenditures at 2%-3% of sales and research and development likely a similar amount, we anticipate Lennox to continue its virtuous circle of reinvesting in the business and delivering surplus capital back to shareholders.

Our stage two forecast period incorporates an estimated investment rate of 35% and earnings before interest growth rate of 6% with perpetual growth of 3%. An 8.6% weighted average cost of capital derives from a market-average cost of equity and the firm’s current capital structure.

We assign Lennox a Narrow Morningstar Economic Moat Rating owing to intangible assets—namely its brand and the related intellectual property/technical know-how behind its products and solutions. We estimate six companies, including Lennox, control most of the North American residential and light commercial HVAC market. Other top players include Carrier, Trane Technologies, Rheem, York (owned by Bosch), and Daikin (Goodman). We estimate Lennox commands a roughly midteens share in the residential and light commercial markets.

HVAC original equipment manufacturers compete mainly on product quality and performance, price, product availability, and service. Although Lennox does offer entry-level HVAC products under the Allied brand (roughly 20% of residential HVAC revenue), its product mix skews toward premium equipment and enjoys a 15%-30% pricing premium depending on make and model. Despite competition, Lennox has consistently capitalized on its brand equity to realize excess returns. Returns on invested capital have materially improved since 2011 because of the sale of underperforming businesses (lower-margin foreign commercial HVAC and refrigeration) and successful cost-reduction initiatives, all while the firm benefited from persistent pricing power amid a strengthening demand environment. We expect the firm will maintain its competitive advantages in residential and light commercial heating and cooling for at least the next 10 years. The Lennox brand is widely recognized and respected as a premium offering in both the residential and light commercial HVAC end markets. The company has a long history of technological know-how and innovation, resulting in superior product quality and performance (efficiency, durability, comfort, noise reduction), which has built brand equity and maintained premium pricing. Innovation is paramount to stay ahead of ongoing regulatory changes and capitalize on consumer demand for the most durable and cost-efficient products.

Lennox has also built its brand via its distribution strategy, which is unique among the peer group. The company owns and operates a distribution network to sell its Lennox-branded products directly to dealers/contractors and ultimately end consumers. This is in stark contrast to industry leader Carrier, which sells residential HVAC almost exclusively through independent distributors. Lennox has approximately 20 dedicated HVAC distribution facilities and approximately 245 Lennox stores throughout North America. Lennox stores act as mini distribution centers; about 80% of the average store is utilized as warehouse space, while the remaining 20% is used for front-end wholesale transactions. We believe the company-owned distribution network allows the firm to better control its sales strategy and marketing efforts, while also directly providing training and support to the contractors that install and service Lennox’s products. Given the company’s consistent record of growth and outsize returns, we suspect that this distribution strategy has contributed to customer retention and brand building. It is far from conclusive, however, that this confers cost or other economic advantages on Lennox. For example, Carrier’s North American HVAC margins are higher than Lennox’s, and Carrier’s distribution model is for all intents and purposes the opposite of Lennox’s. Lennox has a presence in the nonpremium residential HVAC market with its Allied Air Enterprises business, which allows it to access more of the market and maintain higher capacity utilization. Interestingly, Allied Air is sold through third-party distribution, which underscores that management believes the direct model builds the brand and supports its premium positioning.

We don't believe a customer switching cost advantage exists in the residential HVAC market or the light commercial market because replacement costs are low compared with commercial systems. The scale and complexity of a true commercial solution (such as a skyscraper) are vastly different from repairing the HVAC system at a Lowe’s retail store (an example of a major Lennox commercial customer). Depending on the type of repair needed (for example, compressor replacement), purchasing a new HVAC unit can be the better option, and there is no guarantee that the homeowner will purchase the same equipment brand. Furthermore, the residential HVAC service market is served by third-party businesses, so manufacturers don’t generate service revenue from residential equipment sales (aside from revenue from replacement parts, which is modest).

Lennox achieves more dominant share, either through organic growth (expanding its store/distribution footprint) or acquisition of further distribution.

The company expands further into commercial solutions, leveraging its strong intangible assets and adding a more robust moat from customer switching costs.

Lennox acquires additional capabilities.

Pricing power erodes due to insufficient product differentiation.

Independent third parties capture more of the aftermarket/service opportunity.

Lennox's direct sales model eventually weighs on returns.