June 4, 2015

Home Appliance & HVAC Warranty Report:

There are a few very large companies with operations in multiple industries that make it difficult to examine just the warranty expenses of the major appliance and HVAC companies. But if we set them off on their own, we can calculate industry averages for the expenses of others.

The makers of home appliances and HVAC systems, like those in the automotive, computing, and aerospace businesses, are part of a very warranty-intensive industry. But while there's a lot of money involved in the claims and accruals, the industry's warranty expenses are not excessively high as a percentage of revenue.

To reach this week's conclusion, we began with a list of 39 U.S.-based home appliance manufacturers, and a list of 39 makers of heating, ventilation, and air conditioning (HVAC) systems. All 78 companies were on one list or the other, but none were on both lists (although Ingersoll-Rand could be either or both, thanks to its Thermo King truck refrigeration appliances and its Trane and American Standard HVAC brands).

The leading appliance makers included General Electric Co.; Ingersoll-Rand; Jarden Corp.; Manitowoc Company Inc.; and Whirlpool Corp. The leading HVAC manufacturers included A.O. Smith Corp.; Emerson Electric Co.; Honeywell International Inc.; Johnson Controls Inc.; and United Technologies Corp. (the owner of Carrier).

Spread Across Multiple Industries

The biggest problem with these groups is the overlap the membership has with other industries such as aerospace, automotive, power generation, medical equipment, telecommunications, and consumer electronics. And unfortunately, the biggest warranty providers in each group are also among the largest warranty providers in some of those other industries: besides appliances, GE makes turbines, jet engines and medical equipment, while units of the United Technologies conglomerate make jet engines, helicopters, avionics, and elevators.

Left untreated, the totals and averages for the HVAC and appliance groups would have largely mirrored the totals and averages for just United Technologies and GE by themselves. So what we've done in the charts below is to make those two companies separate from the rest.

In Figure 1, the annual claims payments of the 38 HVAC companies and UTC/Carrier are detailed, as are the annual claims payments of the 38 appliance companies plus GE. Readers therefore can make assumptions about how much of UTC's total worldwide claims payments arise from Carrier, and how much of GE's total comes from appliances (which by the way are being sold to Electrolux soon).

Figure 1
Worldwide Warranty Claims of
U.S.-based Home Appliance & HVAC Makers
(claims paid in US$ millions, 2003-2014)

Figure 1

In 2014, all 78 companies paid out about $2.9 billion in claims worldwide, which was about $79 million less than they did in 2013. GE saw claims fall by $100 million but UTC saw claims rise by $57 million. And then there were relatively small declines in claims paid by the other HVAC and appliance companies.

In fact, once GE and UTC/Carrier are set off by themselves, one of the most distinctive features of the rest of the HVAC and appliance claims data is how steady the annual totals of the others have been. There's really not much change from year to year, and that's true for all of their warranty metrics, not just claims payments.

Also, compared to automotive and homebuilding, there's really no deep trench in this group's data to mark the recession. Sure, their peak years may have come before the Lehman Brothers panic, but there's nothing like the cyclical downturns we saw in the car & truck warranty data or in the new home & RV warranty data.

Among the companies that cut their claims payments the most in terms of dollars are Johnson Controls Inc. (owners of York International), Honeywell, Whirlpool, and Ingersoll-Rand. Those that saw the biggest increases included Keurig Green Mountain Inc., Helen of Troy Ltd., and Emerson Electric Co. However, on a proportional basis, one of the biggest reductions was seen at Rockwell Automation Inc., while one of the biggest increases was seen at Nortek Inc.

Warranty Accruals

It's much the same story with warranty accruals. The peak for the entire group of 78 companies came in 2008, as it did for GE and the other appliance companies. And the peak in accruals for just UTC and the HVAC companies came a bit earlier, in 2006.

But last year, the appliance companies raised their accruals by $76 million, while the HVAC companies raised their accruals by $29 million. UTC/Carrier raised their accruals by $24 million. So it was a big cut by GE that drove down the overall total from $2.95 billion in 2013 to $2.93 billion in 2014.

Figure 2
Worldwide Warranty Accruals of
U.S.-based Home Appliance & HVAC Makers
(accruals made in US$ millions, 2003-2014)

Figure 2

It was the third year in a row that warranty accruals in the HVAC/appliance total have been below $3 billion, after six years above that mark. But accruals are still above the levels seen in 2003-2005.

GE made the biggest reduction in accruals by far. In fact, only five other large HVAC or appliance companies made any reductions at all in their accruals: A.O. Smith, Emerson Electric, Jarden, Nortek, and Rockwell Automation. Accrual increases were much more common.

The largest accrual increases, in dollar terms, were seen at Helen of Troy, Honeywell, Ingersoll-Rand, Keurig, United Technologies, and Whirlpool. In relative terms, Helen of Troy was the largest, with accruals jumping from $33 million in 2013 to $54 million in 2014, followed by Keurig, which raised its accruals from $20 to $31 million.

And because of its size, GE's mammoth $152 cut in warranty accruals amounted to only a 20% reduction. However, on a relative basis, none of the other accrual reductions were even half as big. That's the main reason we decided to put GE and UTC on their own: the sheer size of their warranty operations makes even their small changes bigger than the biggest changes of the others.

Warranty Reserves

In Figure 3, we're adding together the year-ending balances of the warranty reserve funds of the 78 HVAC and appliance companies from 2003 to 2014. What immediately becomes apparent is that their peak balance came at the end of 2011, when they held a collective $5.87 billion in their warranty reserves. In 2014 they dipped a bit below $5 billion -- their first time doing so since 2005.

Figure 3
Worldwide Warranty Reserves of
U.S.-based Home Appliance & HVAC Makers
(reserves held in US$ millions, 2003-2014)

Figure 3

Their collective balances fell by $72 million last year. But again, the biggest of the big set the pace. UTC/Carrier's reserve balance fell by $47 million, and GE's fell by $125 million. The other 38 HVAC companies raised their balances by $46 million, and the other 38 appliance companies raised their balances by $53 million.

It was the third consecutive year in which the industry's warranty reserves fell. Besides GE and UTC, other large companies allowing their reserves to fall included Manitowoc, Honeywell, Emerson, and Nortek. Those allowing their balances to rise included Ingersoll-Rand, Johnson Controls, Lennox International Inc., Masco Corp., and Whirlpool. On a relative basis, Keurig let its reserves grow by more than half, and National Presto Industries Inc. let its reserves fall by more than a third of its 2013-ending balance.

Warranty Expense Rates

In Figures 4 through 7, we've taken the claims and accrual data in Figures 1 and 2 and recalculated the expense totals as a percentage of product sales revenue. In that way, the data is adapted to account for changes in sales, which can help to identify the reasons behind some of the increases and decreases noted above.

In Figure 4, we're tracking just the 38 appliance manufacturers besides GE. At the end of 2014, they were spending a little under 1.3% of their product revenue on warranty claims, while setting aside a little over 1.3% of their sales as warranty accruals. Taking their $822 million claims total from Figure 1 and their $901 million accrual total from Figure 2 and working backwards implies total product sales of around $65.8 billion.

Obviously, this is much larger than the U.S. appliance market in 2014, even when measured at retail prices. However, keep in mind that it also includes exports by U.S.-based manufacturers, and it also includes sales of other products by companies that cross industries.

With that in mind, it appears that an expense rate of 1.3% is on the low side of where the industry has been for most of the past 12 years. Expense rates were generally lower than that back in 2003 and 2004, and were generally higher than 1.3% from 2005 to 2010. But that's about where they've been since 2011, give or take a bit for some seasonal oscillations.

Figure 4
All U.S.-based Appliance Makers (except GE)
Average Warranty Claims & Accrual Rates
(as a % of sales revenue, 2003-2014)

Figure 4

Helen of Troy was the only appliance maker to see its 2014 expense rates rise by enough to earn it a spot on the top 10 lists included in the March 12 newsletter. GE was the only appliance company to see its expense rates fall by enough to get it onto a top 10 list (see Figure 5).

Others that cut their claims rates significantly include Middleby Corp. and Ingersoll-Rand. Others that cut their accrual rates significantly include Jarden. Besides Helen of Troy, the only other major appliance company to see both of their warranty expense rates rise significantly last year was Keurig, the coffee maker manufacturer.

GE's Revenue Segmentation

In Figure 5, we've charted GE on its own. However, we have to explain a significant change we made in the way these expense rates are figured. In 2003 and 2004, GE said its warranty expenditures arose primarily from its GE Energy product line. But in 2005, it said the expenses were related primarily to the GE Infrastructure and GE Healthcare product lines.

This had the effect of changing not the size of the expense, but the size of the sales to which the expenses were compared. In 2004, GE Energy reported $17.3 billion in revenue. In 2005, GE Infrastructure, of which GE Energy was part, reported $41.8 billion in revenue. And GE Healthcare reported an additional $15.15 billion in revenue.

Previously, we compared GE's 2003 and 2004 warranty expenses to just GE Energy's revenue, calculating warranty expense rates between 4% and 5%. These, we believe, are close to the true figures for GE's warranted product lines.

However, in 2005 and afterwards, we were forced to compare GE Infrastructure's and GE Healthcare's much larger revenue base to the company's warranty expenses, which dropped the expense rates down to roughly one percent. It was partially caused by a decline in the size of the top of the fraction, as can be seen in Figures 1 and 2. But it was caused more by a massive increase in the size of the bottom of the fraction -- caused merely by the way GE reshuffled the segmenting of its business units in 2005.

Therefore, what we've done in Figure 5 is to refigure the 2003 and 2004 expense rates by dividing them by the same misleadingly larger segment of GE's total revenue as is used in the post-2005 figures, even though the company said those expenses arose primarily from GE Energy. But that just goes to show how misleading it would be to include GE in the appliance group: Even the company itself says most of its warranty expenses originate from products that belong in other industries.

Figure 5
General Electric Co.
Average Warranty Claims & Accrual Rates
(as a % of sales revenue, 2003-2014)

Figure 5

This change in the way we calculate GE's warranty expense rates makes it easier to see the generally downward trend the company has enjoyed over the past 12 years. Only in 2011 did expense rates rise significantly. And in the three years since, they've continued to fall. In 2014, the company's warranty expense rates were a little above and a little below 0.6%, which is significantly lower than the rest of the appliance makers.

However, also note that while the data in Figure 4 is charted in the form of 48 quarterly pairs of expense rates, the data in Figure 5 comes in the form of 48 pairs of annual data. That's because GE discloses its warranty expenses only once a year in its annual report, while most of the other appliance companies report their expenses quarterly.

Declining Expense Rates

In Figure 6, we're tracking the warranty expense rates of just United Technologies Corp., which again shows a decidedly downward trend over the past 12 years. In fact, except for a few bumps and excursions in 2003, 2008 and 2011, it's almost a straight line down from the 2.3% level to the most recent 0.7% level.

Figure 6
United Technologies Corp. (including Carrier)
Average Warranty Claims & Accrual Rates
(as a % of sales revenue, 2003-2014)

Figure 6

The problem is, UTC provides just one set of worldwide warranty expense figures, so we have no way of knowing how much of it is HVAC, how much is aerospace, and how much is other products such as elevators or security/safety equipment.

Only about 26% of UTC's consolidated total revenue comes from the climate control and security business unit, which includes Carrier's HVAC systems. And that business unit includes not just Carrier, but also security products such as intruder alarms, access control systems, and video surveillance systems, as well as a wide range of fire safety products such as hazard detection and fixed suppression products, portable fire extinguishers, fire detection systems, and other safety systems.

Therefore, it's entirely possible that the aerospace product line is cutting its warranty expense rates and is entirely responsible for the good news seen in Figure 6. And it's entirely possible that Carrier is doing all the cost-cutting. We know the segmentation of the company's revenue, but not its warranty expenses. So in order to guess how much warranty expense comes from HVAC products, we would first have to figure out what the industry average might be.

HVAC Industry Average

In Figure 7, we've taken the warranty expenses of 38 other HVAC companies besides UTC/Carrier, and divided them by product sales totals. Unlike Figures 5 and 6, there's no downward trend here. In fact, all the data lies between 0.6% and 1.1%, which isn't really much of a range.

Figure 7
All U.S.-based HVAC Manufacturers (except Carrier)
Average Warranty Claims & Accrual Rates
(as a % of sales revenue, 2003-2014)

Figure 7

The long-term average is just below 0.8%. The 2014 average is closer to 0.75%. In other words, in order to generate a little over $1 billion in warranty claims and an average claims rate of roughly 0.75%, product sales would have to be in the vicinity of $146 billion a year.

If we assume that UTC's Climate, Controls & Security business unit generates warranty expenses at roughly the same 0.8% rate as the rest of the HVAC industry, then its warranty claims and accrual totals are likely to be around $132 million per year. If this were so, then the business unit would account for 38% to 40% of UTC's total warranty expenses, far above their share of total revenue.

In other words, while HVAC equipment has a generally low level of warranty expense rates, it's not as low as what we've seen in the aerospace industry (covered in the April 2 newsletter) or in the medical equipment industry (covered in the April 30 newsletter).

And although our estimates are loaded with assumptions, we'd suggest that the HVAC and appliance businesses at both UTC and GE account for a larger share of warranty expenses than revenue. We can only hope that when GE Appliances transfers over to Electrolux, one or both parties will make some financial disclosures that verify this hunch.

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