Buildings Segment Expected To Be The Growth Driver For Johnson Controls In The Third Quarter

Johnson Controls (NYSE: JCI) is slated to post its third quarter results on July 31, wherein a rise in both revenues and earnings is expected. The increased focus of the company on its Buildings segment is paying off, with 2% organic sales growth, and 7% improvement in field orders noted in the second quarter. The solid growth in this segment can be expected throughout the financial year, given the promising underlying trends. On the other hand, in Q2, while its Power Solutions business reported sales growth of 9%, if you exclude the positive impact of higher lead pass-through and foreign currency, organic sales declined 2%, as a result of lower unit volumes. Looking ahead, new business wins in the segment should help to alleviate the pressure, and positively impact the top-line growth.

We have a $42 price estimate for Johnson Controls, which is higher than the current market price. The charts have been made using our new, interactive platform. The various driver assumptions can be modified by clicking here for our interactive dashboard on JCI’s Third Quarter Expected Performance, to gauge their impact on the EBITDA and price per share metrics.

Factors That May Impact Performance Going Forward

1. Addition of New Salespeople: During the fourth quarter 2017 earnings conference call, the management had stated its intention of adding 400 salespeople in its Buildings segment, net of attrition in FY 2018. This has already been completed by the end of Q2. The company has noted better than expected productivity as a consequence, which has resulted in increased orders. In the quarter, margins on new orders booked in North America increased approximately 100 basis points year-over-year. Based on this progress, JCI plans to continue to add sales capacity in select regions and businesses, to ensure the business is in a good position heading into FY 2019.

2. Synergies and Productivity: 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 significant reduction in annual operating costs from continuing operations, 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. JCI had an incremental $0.05 of synergy (from Tyco merger and Adient spin-off) and productivity savings in the second quarter, and $0.10 in the first six months, and this is anticipated to increase in the second half. The company expects $250 million or $0.23 of incremental savings in FY 2018. Besides the improvement on the cost side, JCI continues to benefit from cross-selling wins.

3. Strategic Review of Power Solutions Business: JCI has stated in the past that it is undertaking a strategic review of its Power Solutions business. This is because the company’s two segments have different dynamics, with a strategic priority given to the strengthening of and investing in its position in the HVAC, fire, and security solutions, and integrated Building Management Systems. Although the company did not reveal any other details regarding this, it did say it is making good progress.

4. Favorable Macroeconomic Environment: Rising GDPs across its key geographic region has resulted in a conducive macroeconomic environment. This has aided the growth in the North American non-residential construction markets. Moreover, the rebound in global oil prices has helped to ease budget constraints in the Middle East, supporting the release of some large infrastructure projects in the region. These trends are expected to continue in the third quarter.

5. Importance of China for Power Solutions: Lower auto production, particularly in the U.S. and Europe, has put pressure on JCI’s industry unit shipments year to date, with the moderate weather weakening the aftermarket demand. Consequently, the global battery shipments declined 5% year-over-year with declines in both OE (Original Equipment) and aftermarket in Q2. On the other hand, China continued to outpace the market, with units up mid-teens and continued strong growth in both OE and aftermarket. Looking ahead, JCI expects production levels to stabilize, given the new business wins in both the spaces. In the second quarter, JCI also witnessed global shipments of start-stop batteries increase 14% year-over-year, with another strong growth quarter in the Americas and China.

6. Impact of Steel and Aluminum Tariffs: JCI is a direct buyer of steel and aluminum totaling approximately $225 million on an annual basis. Given the fact that all of its steel purchases and 70% of its aluminum needs are supplied in-country, the direct impact of the tariffs will be nominal.

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