Key Trends Impacting Johnson Controls’ Business Efficiency Segment

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Johnson Controls‘ (NYSE:JCI) generated 34% of its revenues from its Building Efficiency segment in fiscal year 2013 (Fiscal year end Oct 31). The segment’s revenue contribution towards overall income has declined significantly from 43.8% in fiscal year 2009. This is primarily due to the soft global commercial Heating, Ventilation and Air-Conditioning (HVAC) market and the outpacing growth of Johnson Controls’ Automotive and Power Solutions segments. In this article, we take a deeper look into the segment and the key trends driving its growth in the future.

We currently have a stock price estimate of $52 for Johnson Controls, approximately 6% higher than the current market price.

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Overview of the segment

Johnson Controls Building Efficiency segment sells heating, ventilation, air conditioning (HVAC) and refrigeration systems. The company’s systems include York® chillers, industrial refrigeration products, air handlers, equipment that provide heating and cooling in non-residential buildings and the Metasys control system, which monitors and integrates HVAC equipment with other buildings systems. It also offers technical services which include service and maintenance contracts for HVAC equipment, as well as installation of controls and equipment in new buildings. Johnson Controls generates 43% of its Business Efficiency revenues from HVAC equipment and the remaining 57% from technical services. [1]

Within the segment, Johnson Controls also offers a service called Global Workplace Solutions (GWS), which provides full-time on-site operations staff and real estate and energy consulting services to help customers (mainly corporate and multi-national companies) reduce costs and improve the performance of their buildings. The company’s on-site staff typically performs tasks related to the comfort and reliability of the facility, and manages subcontractors for functions such as food service, cleaning, maintenance and landscaping.

Weak Commercial HVAC Markets Present Headwinds

Building Efficiency revenues declined 2% from fiscal year 2011 to fiscal year 2013. Even as the residential HVAC market in North America has recovered driven by an improving housing market, the commercial HVAC market has remained soft due to weak non-residential construction spending. With Johnson Controls’ HVAC portfolio focused on non-residential buildings, the market weakness has weighed on the segment’s results. Between 2008 and 2013, non-residential construction spending in the U.S. declined 20%, from $710.4 billion to $568.6 billion. [2]

Despite a 5.7% growth in non-residential construction spending in the nine months ended June 30, Building Efficiency revenues declined 4.4%. [3] This is because a large part of Johnson Controls’ Building Efficiency segment is exposed to healthcare and educational construction spending, and government spending in the non-residential construction sector. Spending in these sectors continued to decline in 2014, affecting Johnson Controls Building Efficiency segment. Weak construction spending in Europe has also had a negative impact on the segment’s revenues. [4]

During the third quarter fiscal year 2014 earnings presentation, Johnson Controls said that it is beginning to see improvement in some verticals of the global commercial HVAC market. [5] However, it is too early to consider the improvement to be a sign of a turnaround in the market. Johnson Controls’ acquisition of Air Distribution Technologies (ADT) increases its exposure to these growing verticals along with broadening the HVAC portfolio. This should help bolster Business Efficiency revenues in the present weak construction spending environment.

Even though the weak U.S. HVAC market is likely to present headwinds for Johnson Control’s Business Efficiency segment growth in the near future, the company may benefit from growth in the Asian HVAC market. At a time when Business Efficiency revenues from North America and Europe were declining, revenue from Asia performed relatively well. Between fiscal year 2011 and 2013, the segment’s revenue from Asia grew 10%, and in the first nine months ended June 30, 2014, revenue grew 2%.

The Asia-Pacific region constituted the largest market for HVAC equipment in 2013 and is expected to grow at a strong pace driving the global HVAC market to $120 billion in 2018, compared to $91.5 billion in 2013. [6] Developing markets such as China, India and Indonesia will be the fastest growing markets in Asia due to the rapid economic growth, greater product availability and high demand for cooling systems, which will drive sales of HVAC equipments in these countries. Johnson Controls has significant exposure to the Asian market and is well positioned to take advantage of the growth in sales.

ADT acquisition strengthens Johnson Controls’ position in the HVAC market

During the third quarter fiscal year 2014, Johnson Controls completed its acquisition of ADT, which is one of the largest providers of air distribution and ventilation products for buildings in North America. We believe that ADT will provide growth opportunity for Johnson Controls’ Business Efficiency segment by adding new products to its existing HVAC portfolio. In the near term, this acquisition will likely help lift the company’s revenues through cross-selling opportunities.

ADT’s acquisition is expected to add approximately $150 million to Johnson Controls top line by extending its reach within the U.S. commercial HVAC market and enhancing distribution channels. [7] Additionally, it will help lower costs by $75 million – $100 million. By 2016, the acquisition will add $0.10-$0.15 to the company’s earnings per share.

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Notes:
  1. Johnson Controls 10-K SEC Filing, www.sec.gov []
  2. U.S. Construction Spending Monthly and Annual Data, www.census.gov []
  3. Johnson Controls’s F2014 Q3 earnings form 8-K, July 19 2014, www.johnsoncontrols.com []
  4. Eurostat Production in construction – annual data, ec.europa.eu []
  5. Johnson Controls’ (JCI) CEO Alex Molinaroli on F3Q 2014 Results – Earnings Call Transcript, July 18 2014, www.seekingalpha.com []
  6. World HVAC Equipment, www.freedonia.com []
  7. Johnson Controls to acquire Air Distribution Technologies, April 16 2014, www.johnsoncontrols.com []