Johnson Controls Earning Preview: Organic Growth To Drive Future Earnings

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Johnson Controls

Johnson Controls (NYSE:JCI), a global multi-industrial company, is expected to announce its first quarter 2016 earnings on January 28. The company has set its Q1 EPS guidance at $0.80-$0.83, which is higher than the previous year’s corresponding figure of $0.74, by 8-12%. This figure does not include transaction, integration, and separation costs, which, given the size of the automotive seating business spin-off, are likely to be significant. [1] The company also announced that it expects higher revenues and record profits in fiscal 2016, on the back of growth in developing economies and increasing environmental regulations.

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Johnson Controls Forecasts Higher Revenues In Fiscal 2016

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JCI has provided guidance for fiscal 2016 for its sales and segment income expectations. Consolidated net sales of ~$38.6 billion is expected, a 4% increase versus 2015, and diluted earnings per share are estimated at $3.70 to $3.90, up 8%-14%. The company believes there will be growth in organic sales of 10% in both Building Efficiency and Power Solutions. In the sales guidance, leading the line is the Building Efficiency segment, which is estimated to increase 37%-39%, primarily reflecting the effect of the consolidated Hitachi joint venture, expected to close in the beginning of fiscal 2016. If that is excluded, earnings will increase approximately 9%-11%, with margin improvements of 30 basis points. [2] These profitability improvements suggest increased volumes, along with cost reduction, restructuring initiatives, and improved operational performance.

Growth till 2020

Power Solutions FY2016 sales are believed to increase 9%-11% with higher volumes across all regions. The reason for this solid increase is expected to be two-fold: significant market share gains in all geographies, as well as a 22% increase in the sales of Absorbed Glass Mat (AGM) batteries, used in start-stop and other vehicles. A growth of 11% in global automotive production in China and a 2% rise in North America is assumed, with a slight decrease in Europe. Seeing a high demand for such products, the company is ramping up its investments in new product launches for start-stop and advanced start-stop for automotive applications and lithium-ion solutions for Distributed Energy Storage (DES).

Johnson Controls also anticipates capital investments of $1.3 billion in FY2016, 18% higher than the previous year, reflecting Power Solutions’ increased investments in AGM batteries and China plant capacity, as well as product line expansions in Building Efficiency.

Asia Pacific Investments

Developing Economies To Drive Future Earnings

The company is seeing a greater demand for the HVAC systems the company provides, along with the energy storage and distribution systems, and the new technologies provided for the automotive industry. Increasing urbanization in the developing world, at a rate of 100,000 people a day, will create major opportunities for the company. By 2025, emerging market cities will contribute to 75% of the global GDP. This will result in over $57 trillion building investments through 2030. [3] Furthermore, environmental regulations are driving a need for greater energy efficiency. For example, by 2020 all new construction in China is meant to be ‘green,’ and a 26%-28% reduction in emissions is warranted in the United States. Emerging consumers are also driving energy demand. Renewable sources of energy dominate power capacity additions, with wind and solar energy in developing countries to be a $1.1 trillion market by 2023. Furthermore, the Internet of Things (IoT) will be the number one form of connectivity by 2018, and a growing demand for smart building applications will contribute in making it a $90 billion market by 2020. These trends will help the company to significantly boost their earnings, with $400 billion worth of opportunities for strategic growth across the current platforms of the company.

Growth Platforms

Auto Spin-Off And A Merger With Tyco International

Johnson Controls recently announced that the new automotive seating and interiors business it is spinning off will be named Adient and will become a new publicly traded company on October 3.  Such a move will leave JCI with two core businesses: heating and cooling equipment and controls for buildings, and batteries for cars and trucks. The automotive business reported annual sales of $20.1 billion in the fiscal year ended September 30th, more than half of the sales of the company, but only 36% of its profit. [4] The new company aims to implement new strategies to drive higher levels of growth and profitability, along with strong cash flows, and to raise investment in innovation, to gain market share and to increase value to customers and shareholders. Alex Molinaroli, CEO of Johnson Controls, cited two reasons for the proposed spin-off. The cyclical nature of the auto industry wreaked havoc on the company’s cash flows. Furthermore, the enormous capital investment needed by the seating business was not something JCI was willing to make. [5]

New Auto Company

Johnson Controls and Tyco International announced they have entered into a definitive merger agreement, in a deal that could value the latter as high as $20 billion. Tyco, whose market value is about $13 billion, as compared to JCI’s $23 billion, focuses on fire, security, and video surveillance for commercial buildings through brands such as American Dynamics, Chemguard, and Sensormatic. The sales growth has slowed down in recent quarters, with the sales and profit outlook for 2016 lagging behind analysts’ expectations. With Tyco’s product lines, Johnson Controls will be able to expand the equipment and services it offers for commercial buildings, where developers often look for suppliers with extensive product lines. Currently, JCI provides heating and air conditioning products for commercial and residential buildings. The combination with a company that compliments its own business will help JCI reduce its dependency on the auto parts industry, in the wake of a spin-off. The deal could also take the form of an ‘inversion,’ wherein a U.S. company acquires a foreign-based rival and assumes its lower-tax domicile. This will help JCI to substantially slash its tax bill by shifting its tax domicile to Ireland, where Tyco is headquartered, and where the tax rate is below 20%, compared to 35% in the United States.

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Notes:
  1. JCI Q4 2015, Earnings Call Transcript []
  2. Johnson Controls Forecasts Higher Revenues and Record Profits in Fiscal 2016 []
  3. Johnson Controls Strategic Review and 2016 Outlook []
  4. JCI 10K, FY2015 []
  5. Johnson Controls to Explore Spin-Off of its Auto Business []