It may be June, but I know more than one New England household that turned on its heat this week. We didn’t, but I must admit the thought did cross my mind when I opened the door to the second consecutive 47-degree morning.
This recent cold blast, plus the news that Apple (NASDAQ: AAPL) has selected Ecobee thermostat for HomeKit, got me thinking about smart thermostats and connected homes again – and the growing opportunity for investors in this exciting market.
In the unlikely event you’re unfamiliar with HomeKit, it is Apple’s framework for managing connected devices in the home. The service should be launching in the next couple of months, and could easily spur growth for a number of tech stocks that capitalize on new Apple product launches.
Ecobee, aka the “underdog to Nest,” makes a smart thermostat that differentiates by having multiple sensors for different rooms. The company isn’t public, but it’s certainly worth keeping an eye on if you follow the connected technology trend, or are considering options for a new smart thermostat.
What I find so compelling about this trend is that the connected home isn’t about one company entering the market and dominating. It’s much more about an industry in its infancy where there are many players developing new and improved versions of all the home controls, equipment and appliances that we already use.
Apple’s selection of Ecobee for HomeKit is a perfect example of the early stage of this trend. Nest made a splash, but in the grand scheme of things that was just one pebble in a very large pond. More pebbles, such as Ecobee, are impacting the market every week.
According to Acquity Group, more than two-thirds of consumers plan to buy some sort of connected technology for their homes by 2019. I think that’s probably a conservative estimate. And it even understates the market opportunity, since once consumers buy one connected device for their home, they’re likely to buy more (in my opinion).
Case in point – this past winter I purchased a Nest thermostat – owned by Google (NASDAQ: GOOGL – for our second home in Vermont. It’s a big stress reducer given that I can monitor the temperature when we’re not there.
But it’s also just a gateway device in many ways; I expect to add a boiler monitor and possibly an exterior camera this fall. A camera would help determine when the roof and driveway needs extra shoveling (with all the snow this winter we had one ice dam that leaked inside), and the cost is far less than the cost of repairs.
We’re also considering an electronic door lock that can be controlled from a smartphone. It would mean no more hiding a key in locations that any crook in the neighborhood could uncover in five seconds.
So while a lot of market research on the connected home focuses on thermostats, since they are the easy target, I think investors should realize they are just the tip of the iceberg. “Dumb” thermostats will be virtually non-existent in a decade, if not sooner. And you will be notified by an app when your boiler is due for an air filter, your water supply is leaking or your air conditioner needs to be serviced. You can do all of these things now, but I think they’ll be mainstream in what seems like the blink of an eye.
The opportunity is big enough to attract massive companies such as Philips (NYSE: PHG), Apple and Google (which also owns Dropcam). The presence of these companies signals that the trend is very real and very big. It’s potentially a $10 billion annual market which could grow fourfold over the next three years.
I love the products these three companies are coming out with – they are very well designed (and marketed) for everyday consumers.
But as an investor there is one company that I like more than Apple, Google and Philips for connected-home exposure. This company isn’t as big as Apple or Google, but as a percentage of revenue it has much more exposure to housing.
The Best Large-Cap Stock to Play the Connected Home
The key innovation that should get credit for the smart home trend is really a very basic device by today’s standards. It was invented in 1885 by Albert Butz, and was called the damper flapper.
The damper flapper was an early version of a coal furnace thermostat. Over the years Butz’s thermostat was improved upon until thermostatic heating control became the standard for regulating temperature.
It was also the key innovation that propelled a small company’s growth through the early 1900s. That company was the Minneapolis-Honeywell Regulator Company, which is known today as Honeywell (NYSE: HON).
Honeywell has since grown into an $82 billion industrial technology company, but the thermostat is still what people know best about it. Its T87 “The Round” thermostat has been a key element of home heating systems for over 50 years. And they’re still being sold today.
In fact, Honeywell owns the thermostat market with nearly 40% market share. It also has a lot of exposure to buildings and construction with a wide variety of other products. Its most recent financials state that a full 24% of sales are derived from the homes and buildings market.
The company has a new wave of products that improve and expand its ability to create a true connected-home experience. The Lyric, Honeywell’s new smart thermostat, is probably the most well-known. But others cover the major areas of consumer interest, including home security cameras and locks, lighting, window shades and ceiling fans.
While home heating and appliances are a significant part of its business, Honeywell has significant exposure to other industries, including aerospace and security. Behind each of these industries are long-term growth trends, which is part of why Honeywell is such a durable investment. It’s also exceptionally well-run.
Honeywell isn’t exactly a rapid growth company. Sales will probably only grow at around 3% annually for the next few years. Earnings per share growth should be much better though, coming in between 7% and 10% annually through 2017. That EPS growth should trump what the S&P 500 will deliver.
There is upside potential to these conservative estimates. Share buybacks should add incremental EPS growth. And Honeywell is likely to add growth through acquisitions over the next three years.
Management has a rough goal to spend $10 billion on acquisitions between 2014 and 2018, but over the last 12 months it has only spent $200 million. That leaves a pretty wide gap, which is likely to be filled by several industrial, aeronautical and specialty-materials-related acquisitions. Housing and connected-home-related acquisitions are sure to be on the list of potentials as well.
The connected home is a gradual trend that has been developing for years, but it is starting to accelerate as consumer options go up and prices come down. People don’t swap out their thermostats, locks, lights and large appliances overnight – there’s no need to. But they will do so over time as they need to be replaced, and as the new construction market recovers. This dynamic should keep the market growing for at least a decade.
Growth investors should own Google and Apple for their awesome products and technologies, which include some smart-home exposure. But don’t overlook Honeywell – an entrenched industrial titan that should churn out reliable returns year after year.
Buy it for the dividend, the stability, or the likelihood that the stock will continue to outperform the market over the next decade.
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