Why Johnson Controls Stock Looks Overvalued At $34?

Johnson Controls’ stock (NYSE: JCI) has lost 17% of its value year-to-date, currently trading at levels of around $34. While the stock fell close to 43% to about $23 as the markets collapsed in March, it has risen by 46% from these lows.

Why? While the Covid-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus announced in late March helped the markets stage a strong recovery. In addition to this, investors are now expecting a quicker economic rebound, which will bode well for Johnson Controls.

But is this all there is to the story?

Not quite. Despite the massive rally, Trefis estimates Johnson Controls Valuation at about $30 per share, roughly 12% below the current market price based on two key risks.

The first risk we see is to Johnson Controls’ near-to-medium term revenue growth. With the economy barely limping back to normalcy following Covid-19 related shutdowns, and unemployment at multi-decade highs in the U.S., the real estate sector is expected to take a hit. The project timelines and cash flows for real estate developers are affected due to the halt in certain construction activities. Moreover, several service oriented companies are now expecting to have a higher percentage of the workforce to work from home even after the Covid-19 crisis winds down. Such initiatives will likely take a toll on companies such as Johnson Controls, which provides building solutions.

Johnson Controls reported a 6% drop in revenues in Q2 fiscal 2020 (ending March), primarily led by lower sales in Asia Pacific, while the adjusted earnings grew 31% led by margin expansion. The company has withdrawn its full year guidance. Revenues are expected to take a sharp hit in Q3 fiscal 2020, due to lockdowns being imposed in various cities and muted construction activity.

We project that Johnson Controls’ revenue will stand at about $22.4 billion for fiscal 2020, marking a decline of about 7% year-over-year. This compares with the growth rate of a little over 2% in 2018 and 2019.

The second key risk stems from Johnson Controls’ high valuation multiple, compared to its own historical multiple over the recent years. The stock now trades at over 19x its projected 2020 earnings per share of about $1.90. In comparison, to earn close to $1.90 per year from a bank, you’d have to deposit about $190 in a savings account today (assuming 1% interest rate), so about 100x desired earnings. At Johnson Controls’ current share price of roughly $34, we are talking about a P/E multiple of just over 19x. And we think a figure closer to 16x will be appropriate.

That said, there is a long-term opportunity in the buildings solutions business, and Johnson Controls can capitalize on it.

Climate change consciousness is growing. There is considerable social and political pressure on fossil fuel producers to reduce emissions, and on consumers to reuse, reduce, recycle! This also means that investors are looking at greener industries much more favorably and Johnson Controls is one such stock investors could look at.

Johnson Controls is one of the top players in smart buildings solutions. A smart building is referred to as a building that uses automated processes to control the building’s operations including heating, ventilation, air conditioning, lighting, and security among other systems. This not only improves the overall performance, it significantly reduces energy use (up to 50% in some cases), minimizing the environmental impact of buildings.