Why Johnson Controls’ Stock Is Worth $42

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JCI: Johnson Controls logo
JCI
Johnson Controls

Johnson Controls (NYSE: JCI) has had a strong FY 2018 till now (year ended September 2018), reporting growth in revenues and earnings, and beating consensus expectations on both metrics in the three quarters reported. The increased focus of the company on its Buildings segment is paying off, with impressive organic growth noted in the segment, along with an improvement in the number of field orders. The solid growth in this segment can be expected in the near term, given the promising underlying trends. While the Power Solutions segment reported weak results in the first two quarters, this reversed in Q3, with 14% reported sales growth, 10% organic sales improvement, and higher unit volumes recorded by the company. Looking ahead, new business wins in the segment and higher global adoption of start-stop units should positively impact the top-line growth. JCI has tightened its full year earnings guidance for FY 2018 to $2.80-$2.82, from $2.75 to $2.85 earlier. As per our estimates, we expect JCI to post an EPS of $2.82 for FY 2018, and $3.03 for FY 2019.

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 Our Outlook For Johnson Controls In FY 2019, to gauge their impact on the EBITDA and price per share metrics.

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We have arrived at a $42 price estimate for Johnson Controls based on revenue projections of $32.4 billion for FY 2019, EBITDA of $4.5 billion, a P/EBITDA multiple of 8.9, and a share count of 944.6 million. The market price stood at $36 as of September 26, 2018, implying our price estimate is higher by 15%.

The revenue and EBITDA margin growth forecasts have been based on the following factors:

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 had already been completed by the end of Q2, and consequently, JCI upped the hiring of incremental sales professionals to 900, with 775 already hired by the end of the third quarter. The company has noted better than expected productivity as a consequence, which has resulted in increased orders. In the third quarter, margins on new orders booked in North America increased approximately 110 basis points year-over-year, versus 70 bps in Q1 and 100 bps in Q2. 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 $70 million or $0.06 of synergy (from Tyco merger and Adient spin-off) and productivity savings in the third quarter, and $0.16 in the first nine months. 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. Favorable Macroeconomic Environment: Rising GDPs across its key geographic region has resulted in a conducive macroeconomic environment, despite FX volatility, inflationary pressures, and trade policy concerns. 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 near term.

4. Importance of China for Power Solutions: China continued to outpace the market, with units up 30% in both OE (Original Equipment) and aftermarket in Q3. Looking ahead, JCI expects production levels to stabilize, given the new business wins in both the spaces. In the third quarter, JCI also witnessed global shipments of start-stop batteries increase 30% year-over-year, with strong growth reported across the Americas, EMEA, and China.

5. 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 minor. The company is still evaluating the impact of the tariffs on Chinese original goods, as per Section 301, but expects this to have a minimal impact in Q4. Additionally, JCI is also actively managing pricing in the supply chain, as well as externally, to mitigate any impact.

Johnson Controls is also 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. Moreover, developing advanced battery technology is a very capital-intensive business, requiring significant investments. Although the company did not reveal much regarding this, it did say the review will be complete by the end of Q4, and more details will be provided with that earnings release.

Click here to see our complete analysis of Johnson Controls

 

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