Margin Expansion Will Be A Key Growth Driver For Johnson Controls

by Trefis Team
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Margin expansion driven by cost cutbacks and shift in business towards higher margin segments will be a key growth driver for Johnson Controls (NYSE:JCI) in the coming years. Last quarter, driven by these two factors, the company’s earnings rose by 33% annually to 69 cents per share, despite slower growth in its revenues. [1] In our opinion, Johnson Controls’ margins will continue to expand for the foreseeable future driving growth in its results.

We currently have a stock price estimate of $48 for Johnson Controls, marginally above its current market price.

See our complete analysis of Johnson Controls here

Ongoing Cost Reduction Measures Will Help Expand Margins

Around a year-and-half back Johnson Controls initiated multiple cost reduction measures to combat its challenging macro environment. At the time, the company faced declining construction spending and automotive production in Europe and weak growth from North America. So, from late 2012 through 2013, Johnson Controls among other measures lowered its headcount and consolidated its production facilities. As a result, its segment profit margin rose from 6% in fiscal year 2012 to 7.7% in fiscal year 2013, which ended on September 30, 2013. [2] These restructurings remain underway currently and therefore we anticipate the company’s margin to expand further in the current fiscal year.

Shift In Business Towards Higher Margin Segments

Additionally, we figure that the ongoing shift in Johnson Controls’ business from its auto interior and auto electronic segments to its auto batteries and building efficiency segments will expand its margins. The company’s auto interior and electronic segments have margins in the low single digits, compared to margins of around 15-16% in its auto batteries segment and high single digit margins in its building efficiency segment, which makes York brand air conditioners and other building systems. [3]

Late last year, as part of this deliberate shift in focus towards higher margin businesses , Johnson Controls sold off its Homelink unit, which was part of its auto electronic segment, to Gentex Corp. for $700 million. [4] Then, earlier this year, the company sold off the remaining units of its auto electronic segment to Visteon Corp. for $265 million. [5] We figure this divestiture of the auto electronic segment will push up the company’s margins in the current fiscal year.

In addition, Johnson Controls is undertaking a strategic review of its auto interior business, which has margins of around 1%. [3] This segment which makes door/floor/front panels in addition to a few other automobile interiors constituted around $4 billion of the company’s $42.5 billion revenues in fiscal year 2013. [2] We figure the strategic review of the auto interior business is driven by its extremely low margins and if proceeds from the sale of this segment were invested by the company in its auto batteries or building efficiency segments, then its return on investment will likely improve. The company too figures that there are better growth opportunities in its auto batteries and building market related businesses and therefore it is likely that parts of the auto interior business will get divested in the coming months.

However, unlike its auto electronic segment, which generated around a billion in annual revenues, the auto interior business is much larger with several manufacturing plants spread across many major markets. Thus, even its partial sale will take time. Nonetheless, in our opinion, it will be a step in the right direction as it will expand the company’s overall margin, accelerate its growth and improve its return on investment.

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Notes:
  1. Johnson Controls fiscal 2014 Q1 earnings form 8-K, January 23 2014, www.johnsoncontrols.com []
  2. Johnson Controls fiscal 2013 10-K, October 29 2013, www.johnsoncontrols.com [] []
  3. Johnson Controls strategic review and 2014 outlook, December 18 2013, www.johnsoncontrols.com [] []
  4. Johnson Controls completes sale of HomeLink business, September 27 2013, www.johnsoncontrols.com []
  5. Johnson Controls sells auto electronics business to Visteon Corp, January 13 2014, www.johnsoncontrols.com []
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