Lennox (LII)

Climate control solutions innovator Lennox International (NYSE:LII) announced better-than-expected revenue in Q1 CY2025, with sales up 2.4% year on year to $1.07 billion. Its non-GAAP profit of $3.37 per share was 3.6% above analysts’ consensus estimates.

Company Overview

Based in Texas and founded over a century ago, Lennox (NYSE:LII) is a climate control solutions company offering heating, ventilation, air conditioning, and refrigeration (HVACR) goods.

Many HVAC and water systems companies sell essential, non-discretionary infrastructure for buildings. Since the useful lives of these water heaters and vents are fairly standard, these companies have a portion of predictable replacement revenue. In the last decade, trends in energy efficiency and clean water are driving innovation that is leading to incremental demand. On the other hand, new installations for these companies are at the whim of residential and commercial construction volumes, which tend to be cyclical and can be impacted heavily by economic factors such as interest rates.

Other companies offering heating, ventilation, air conditioning, and refrigeration (HVACR) goods include Carrier Global (NYSE:CARR), Trane Technologies (NYSE:TT), and Johnson Controls International (NYSE:JCI)

A company’s long-term sales performance is one signal of its overall quality. Any business can have short-term success, but a top-tier one grows for years. Unfortunately, Lennox’s 7.5% annualized revenue growth over the last five years was mediocre. This wasn’t a great result compared to the rest of the industrials sector, but there are still things to like about Lennox.

Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. Lennox’s annualized revenue growth of 8.3% over the last two years aligns with its five-year trend, suggesting its demand was stable.

We can dig further into the company’s sales dynamics by analyzing its organic revenue, which strips out one-time events like acquisitions and currency fluctuations that don’t accurately reflect its fundamentals. Over the last two years, Lennox’s organic revenue averaged 8.4% year-on-year growth. Because this number aligns with its normal revenue growth, we can see the company’s core operations (not acquisitions and divestitures) drove most of its results.

This quarter, Lennox reported modest year-on-year revenue growth of 2.4% but beat Wall Street’s estimates by 4.6%.

Looking ahead, sell-side analysts expect revenue to grow 3.3% over the next 12 months, a deceleration versus the last two years. This projection is underwhelming and indicates its products and services will face some demand challenges. At least the company is tracking well in other measures of financial health.

All else equal, we prefer higher gross margins because they usually indicate that a company sells more differentiated products and commands stronger pricing power.

Lennox’s gross margin is slightly below the average industrials company, giving it less room to invest in areas such as research and development. As you can see below, it averaged a 28.7% gross margin over the last five years. Said differently, Lennox had to pay a chunky $71.29 to its suppliers for every $100 in revenue.

In Q1, Lennox produced a 30.6% gross profit margin, down 1.8 percentage points year on year. On a wider time horizon, however, Lennox’s full-year margin has been trending up over the past 12 months, increasing by 1.1 percentage points. If this move continues, it could suggest better unit economics due to more leverage from its growing sales on the fixed portion of its cost of goods sold (such as manufacturing expenses).

Lennox has been a well-oiled machine over the last five years. It demonstrated elite profitability for an industrials business, boasting an average operating margin of 16.1%. This result was particularly impressive because of its low gross margin, which is mostly a factor of what it sells and takes huge shifts to move meaningfully. Companies have more control over their operating margins, and it’s a show of well-managed operations if they’re high when gross margins are low.

Looking at the trend in its profitability, Lennox’s operating margin rose by 4.4 percentage points over the last five years, as its sales growth gave it operating leverage.

This quarter, Lennox generated an operating profit margin of 14.5%, down 1.4 percentage points year on year. Since Lennox’s gross margin decreased more than its operating margin, we can assume its recent inefficiencies were driven more by weaker leverage on its cost of sales rather than increased marketing, R&D, and administrative overhead expenses.

Revenue trends explain a company’s historical growth, but the long-term change in earnings per share (EPS) points to the profitability of that growth – for example, a company could inflate its sales through excessive spending on advertising and promotions.

Lennox’s EPS grew at a spectacular 17.4% compounded annual growth rate over the last five years, higher than its 7.5% annualized revenue growth. This tells us the company became more profitable on a per-share basis as it expanded.

We can take a deeper look into Lennox’s earnings quality to better understand the drivers of its performance. As we mentioned earlier, Lennox’s operating margin declined this quarter but expanded by 4.4 percentage points over the last five years. Its share count also shrank by 7.8%, and these factors together are positive signs for shareholders because improving profitability and share buybacks turbocharge EPS growth relative to revenue growth.

Like with revenue, we analyze EPS over a more recent period because it can provide insight into an emerging theme or development for the business.

For Lennox, its two-year annual EPS growth of 24.3% was higher than its five-year trend. We love it when earnings growth accelerates, especially when it accelerates off an already high base.

In Q1, Lennox reported EPS at $3.37, down from $3.47 in the same quarter last year. Despite falling year on year, this print beat analysts’ estimates by 3.6%. Over the next 12 months, Wall Street expects Lennox’s full-year EPS of $22.48 to grow 5.7%.

If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

Lennox has shown robust cash profitability, enabling it to comfortably ride out cyclical downturns while investing in plenty of new offerings and returning capital to investors. The company’s free cash flow margin averaged 10.9% over the last five years, quite impressive for an industrials business.

Taking a step back, we can see that Lennox’s margin dropped by 1.8 percentage points during that time. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. If the longer-term trend returns, it could signal increasing investment needs and capital intensity.

Lennox burned through $61.3 million of cash in Q1, equivalent to a negative 5.7% margin. The company’s cash burn was similar to its $51.8 million of lost cash in the same quarter last year. These numbers deviate from its longer-term margin, but we wouldn’t read too much into the short term because investment needs can be seasonal, leading to temporary swings.

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).

Lennox’s five-year average ROIC was 50.4%, placing it among the best industrials companies. This illustrates its management team’s ability to invest in highly profitable ventures and produce tangible results for shareholders.

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Lennox’s ROIC has unfortunately decreased significantly. Only time will tell if its new bets can bear fruit and potentially reverse the trend.

Lennox reported $222.9 million of cash and $1.49 billion of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company’s debt level isn’t too high and 2) that its interest payments are not excessively burdening the business.

With $1.13 billion of EBITDA over the last 12 months, we view Lennox’s 1.1× net-debt-to-EBITDA ratio as safe. We also see its $20.7 million of annual interest expenses as appropriate. The company’s profits give it plenty of breathing room, allowing it to continue investing in growth initiatives.

We were impressed by how significantly Lennox blew past analysts’ organic revenue and reported revenue expectations this quarter. EPS also beat, and the company raised full-year EPS guidance. Management added that "revenue is still anticipated to increase by approximately 2%. We now expect additional pricing gains to overcome tariffs while preserving profit margins and offsetting the impact of potential volume declines." Despite the good news, shares traded down 4.3% to $534.99 immediately after reporting.

Updated: June 14, 2025 at 11:07 PM EDT

Before investing in or passing on Lennox, we urge you to understand the company’s business quality (or lack thereof), valuation, and the latest quarterly results - in that order.

In our opinion, Lennox is a good company. Although its revenue growth was mediocre over the last five years and analysts expect growth to slow over the next 12 months, its stellar ROIC suggests it has been a well-run company historically. And while its diminishing returns show management's recent bets still have yet to bear fruit, its spectacular EPS growth over the last five years shows its profits are trickling down to shareholders.

Lennox’s P/E ratio based on the next 12 months is 22.6x. Looking at the industrials landscape right now, Lennox trades at a pretty interesting price. For those confident in the business and its management team, this is a good time to invest.

Wall Street analysts have a consensus one-year price target of $559.17 on the company (compared to the current share price of $537.75), implying they see 4% upside in buying Lennox in the short term.