Higher Global Automotive Production & Cost Cuts Will Likely Lift Johnson Controls’s Earnings

Johnson Controls (NYSE:JCI) will announce the second quarter results of its fiscal 2014 Wednesday, April 23. The maker of auto batteries, auto seats and York brand air conditioners is coming off a good first quarter in which its revenues rose by 5% annually and profits by 33% annually on higher global automotive production and gains from cost reduction measures. ^[1]

In the second quarter, we anticipate the trend to continue. The company will likely post healthy growth in its top line on continued strength from the global auto sector, partially offset by weakness from the European building market. Johnson Controls’s second quarter profits will also likely rise on higher margins driven by cost cutbacks and reduced dependence on the low margin auto businesses.

Separately, we will watch the company’s results for any new announcement related to its auto interiors business, which is currently under strategic review. We figure Johnson Controls could sell this business as it has extremely low margins of around 1%. ^[2] We currently have a stock price estimate of $50.50 for Johnson Controls, around 5% ahead of its current market price.

See our complete analysis of Johnson Controls here

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Margin Expansion Will Drive Second Quarter Profits

Around a year-and-half back Johnson Controls initiated multiple cost reduction measures to combat a challenging macro environment. At the time, the company was faced with 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 to reduce its costs. As a result, the company’s segment profit margin improved from 6% in fiscal 2012 to 7.7% in fiscal 2013, which ended on September 30, 2013. ^[3] Margins rose further in the first quarter of fiscal 2014 on gains from these cost reduction measures. As these cost cutbacks remain underway currently, we anticipate Johnson Controls’s margins to expand further in the second quarter, growing its profits.

Another factor which is expanding Johnson Controls’s margins is its shift toward higher margin businesses. As part of this shift, the company earlier this year divested its auto electronics segment, which had margins in low single digits, and it is currently undertaking a strategic review of its auto interior segment. This auto interior segment also has extremely low margins of around 1%. It makes door/floor/front panels among other automobile interiors, and constituted approximately $4 billion of Johnson Controls’s $42.7 billion revenues last fiscal year. ^[3] We figure divestiture of the auto interior business will raise the company’s margins as well as unlock capital that could be invested in other businesses to earn a higher rate of return. In the second quarter results, we will look for any new information related to the company’s ongoing review of its auto interior segment.

Higher Global Automotive Production Will Likely Lift Top Line

Apart from cost reduction and shift towards higher margin businesses, Johnson Controls’s second quarter results will gain from higher global automotive production. The company in its outlook for fiscal 2014, forecast automotive production to rise across all major markets including North America, China and Europe. In the first quarter, it turned out so and in the second quarter we anticipate the trend to continue. The company through auto batteries, auto seating and auto interiors generates roughly 65% of its overall revenues from the global auto sector. ^[3]

The remaining portion of the company’s revenue comes from global building markets, which it serves through its York brand air conditioning systems and other mechanical systems that provide heating and cooling in buildings. It is here that the company’s revenues could get impacted by weak demand from European building markets. Non-residential construction spending in Europe is weak, which is weighing on demand for Johnson Controls’s building heating and cooling solutions. However, with the economic environment improving we figure the demand from European building markets will improve gradually as the year progresses.

All in all, Johnson Controls will likely post a good second quarter.

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1. Johnson Controls fiscal 2014 Q1 earnings form 8-K, January 23 2014, www.johnsoncontrols.com [↩]
2. Johnson Controls strategic review and 2014 outlook, December 18 2013, www.johnsoncontrols.com [↩]
3. Johnson Controls fiscal 2013 10-K, October 29 2013, www.johnsoncontrols.com [↩] [↩] [↩]