Modernization Orders Will Expand Global Connected Services

Key Takeaways

• Modernization and global service expansion drive high-margin recurring revenue, leveraging aging infrastructure trends and strong customer retention for sustained growth.
  
• Innovation in smart, energy-efficient solutions and major cost-saving initiatives enhance profitability and position Otis for premium projects and expanded market share.
  
• Weakness in China, slower commercial real estate demand, service disruption risks, supply chain issues, and declining construction all threaten Otis's long-term growth and profitability.

Catalysts

Engages in manufacturing, installation, and servicing of elevators and escalators in the United States, China, and internationally.

• The accelerating momentum in modernization orders-up 22% in the quarter and supported by a record-high backlog-positions Otis to benefit from the global trend of aging building infrastructure, which is expected to drive a multi-year growth cycle for modernization and associated high-margin service revenue, positively impacting both revenue and earnings.
  
• Sustained expansion of Otis's service portfolio, supported by strong customer retention, pricing power, and geographic growth (especially in Asia and the Americas), continues to increase high-margin recurring revenue, which has already contributed to record service margins and is likely to support further net margin expansion.
  
• Ongoing investments in energy-efficient, connected elevator systems and services capitalize on global demand for sustainable and smart building solutions, allowing Otis to compete for premium projects and command higher pricing, supporting both revenue growth and margin improvement.
  
• Significant cost-saving initiatives, including the UpLift and China transformation programs, are on track to deliver over $240 million in annual run-rate savings, improving operating leverage and underpinning stronger net margin and earnings growth even amid near-term pressure in new equipment sales.
  
• Robust growth in the Americas and Asia-Pacific markets for new equipment-excluding China-aligns with long-term urbanization and emerging market expansion, increasing Otis's installed base and providing future tailwinds for both equipment sales and high-margin service revenue streams.

Otis Worldwide Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Otis Worldwide's revenue will grow by 5.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 10.7% today to 11.9% in 3 years time.
• Analysts expect earnings to reach $1.9 billion (and earnings per share of $5.17) by about September 2028, up from $1.5 billion today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 24.6x on those 2028 earnings, up from 22.8x today. This future PE is lower than the current PE for the US Machinery industry at 24.7x.
• Analysts expect the number of shares outstanding to decline by 1.75% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.5%, as per the Simply Wall St company report.

Otis Worldwide Future Earnings Per Share Growth

Risks

• Persistent weakness and heightened competition in China are resulting in a significant decline in New Equipment sales and negative pricing impact, with a more than 20% drop in orders and ongoing margin compression-threatening both revenue growth and net margins long-term if China fails to stabilize.
  
• Broader industry shifts toward remote work and softer demand for commercial real estate, especially office buildings in developed markets, contribute to sluggish new installation demand and prolonged project delays in the Americas and EMEA, limiting top-line growth and installed base expansion.
  
• Increased reliance on the Service segment for profitability creates risk if building owners adopt new maintenance technologies, competitors' IoT-enabled solutions, or alternative vertical transportation systems, which could erode Otis's recurring service revenues and profitability over time.
  
• Accelerating supply chain challenges, including tariff headwinds, labor tensions, and project execution slowdowns, have led to temporary production facility furloughs, cash flow timing issues, and higher compliance costs-putting pressure on operating profit and free cash flow conversion.
  
• Demographic and secular shifts, such as plateauing urbanization in developed economies and declining construction in key regions like Europe and Japan, threaten to further limit the long-term pipeline for both new installations and modernization, hindering sustained revenue and earnings growth.

Valuation

• The analysts have a consensus price target of $100.923 for Otis Worldwide based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $134.0, and the most bearish reporting a price target of just $90.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $16.4 billion, earnings will come to $1.9 billion, and it would be trading on a PE ratio of 24.6x, assuming you use a discount rate of 8.5%.
• Given the current share price of $88.01, the analyst price target of $100.92 is 12.8% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.