Why Are We Bullish On Johnson Controls?

by Trefis Team
Johnson Controls
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FY 2017 (year ended September 2017) was a big year for Johnson Controls (NYSE: JCI) in terms of reorganization. The company made significant progress on the integration with Tyco, completed the spin-off of Adient, and divested ADT South Africa and Scott Safety, besides several other small non-core assets. JCI also completed a major reorganization of its operating structure across the globe, most recently in North America. The alignment of the cost structure with Tyco helped to generate $300 million in incremental cost synergies and productivity savings, driving 90 basis points of margin expansion for the year. However, the significant restructuring efforts undertaken by the company in recent years has resulted in declining cash profits, as a result of which the company’s stock has performed pretty poorly. Looking ahead, we expect an over 3% growth in revenues, close to 5% increase in EBITDA, and a 6.4% improvement in the cash profits. Consequently, we have arrived at a $45 price estimate for the company, which is roughly 24% higher than the current market price.

We have also created an interactive dashboard which shows the forecast trends; you can modify the key value drivers to see how they impact the company’s revenues, bottom-line, and valuation.

Developing Markets Expected To Drive Revenue Growth For Buildings Segment

Key reasons why we think the developing economies will be key drivers for revenue growth are:

1. Growing Construction Spending- Residential as well as non-residential construction spending from the developing countries is rising, as a large number of people in these countries are moving from rural areas to cities. The growth potential for the HVAC market is huge, as the percentage of the population living in cities in the less developed regions of the world (all of Africa, Asia excluding Japan, Latin America, and the Caribbean) is far below the percentage of population living in cities in the developed regions of the world.

2. Favorable Demographics- This will ensure long-term growth for the company, as it will lead to a higher demand for security, productivity, comfort, and mobility. The bulk of this demand will be centered around Asia Pacific, where a substantial infrastructure gap can be seen across the region, and where the share of its global infrastructure spending is set to increase from 30% in 2012, to 40% in 2018, and 48% by 2025. Moreover, the region’s growing prosperity is also igniting social infrastructure development. This includes hospitals and senior centers, fueled by an increasingly aging population, particularly in Japan and Korea. In contrast, the less developed economies, which currently have some of the youngest populations, will witness a greater need for schools and education centers.

3. Increasing Urbanization- Higher urbanization rates place increased pressure on weak, under-invested city infrastructure, and as cities become more sophisticated, infrastructure development will trend toward achieving a higher quality of life. There will be a need for smarter, more innovative, and technologically savvy buildings.

Besides the aforementioned reasons, increased emphasis on energy conservation and government regulations across the world will ensure higher demand for JCI’s products. Energy efficiency is at the core of Johnson Controls, and the company has 125 years of experience in developing and providing energy efficient solutions, which are innovative, cost-effective, and scalable.

Increasing Adoption Of AGM Batteries To Boost Power Solutions Revenue

With rising fuel prices as well as stricter vehicle emission norms, advanced batteries that help lower fuel consumption and emissions, are occupying an increasing share of the global auto battery market. It is here that Johnson Controls’ AGM (Absorbent Glass Mat) batteries, by powering start-stop technology in vehicles, are capturing the growth being driven by these two trends. Estimates from Johnson Controls suggest that its AGM batteries improve vehicle fuel efficiency by up to roughly 5%, saving consumers money. Additionally, these batteries lower vehicle emissions helping auto manufacturers meet stricter emission norms. Currently, more than half of new vehicles built in Europe feature this technology. Other regions, especially North America and China, are also catching up to adopt start-stop technology in vehicles. According to the company, between 2016 and 2020, the global market for the start-stop technology will surge from 25 million to 65 million vehicles in North America, Europe, and China. In our opinion, as start-stop technology is easier to implement and comes with a lower price premium than hybrid and electric technologies, its adoption in cars could grow to levels anticipated by the company.

Cost Reduction Measures Will Expand Margins

JCI committed to a significant restructuring plan in FY 2017 related to cost reduction initiatives. The costs consist primarily of workforce reductions, plant closures, and asset impairments. The company currently estimates that upon completion of the restructuring action, there will be a reduction in annual operating costs from continuing operations by approximately $280 million, which is primarily the result of lower cost of sales and selling, general, and administrative expenses due to reduced employee-related costs, depreciation, and amortization expense. Such measures will result in an improvement in the margins.

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