This HVAC Company Appears To Be A Better Bet Over Johnson Controls Stock

We think that Trane Technologies stock (NYSE: TT), a heating, ventilating and air conditioning (HVAC) systems, building management systems, and controls company, currently is a better pick compared to its industry peer Johnson Controls stock (NYSE: JCI), despite Trane Technologies being the more expensive of the two. Trane Technologies trades at about 3.3x trailing revenues, compared to 2.3x for Johnson Controls. Although both the companies have seen a pickup in demand of late, Trane Technologies’ financial performance has been better over the recent years. However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical revenue growth as well as operating margin growth. Our dashboard Johnson Controls vs Trane Technologies: Industry Peers; Which Stock Is A Better Bet? has more details on this. Parts of the analysis are summarized below.

1. Trane Technologies Revenue Growth Has Been Better

Trane Technologies’ revenue growth over the last twelve month period was slightly better than Johnson Controls (9% vs. 3%), given a rebound in demand for residential climate control products. Note that Johnson Controls’ business had a more profound impact during the pandemic, compared to Trane Technologies, given a decline in non-residential construction activity, especially in the North America region, which is the largest segment, accounting for nearly 40% of the company’s total sales.

Looking at a longer time-frame, Johnson Controls’ revenue over the last three fiscal years grew at a CAGR of -0.8%, as compared to -4.3% CAGR for Trane Technologies. Note that Trane Technologies was formed after the spin-off of Ingersoll-Rand’s industrial segment and subsequent merger with Gardner Denver subsidiary, thereby impacting the overall revenue change. If we were to look at the adjusted revenue, it actually grew at CAGR of 3.7%.

Now with economies opening up gradually, the demand for building products, including HVAC, is expected to rise going forward. In fact, Johnson Controls has guided for revenues to grow at 6% to 7% CAGR through fiscal 2024. Our Johnson Controls Revenues dashboard provides more insight on the company’s revenues. Trane Technologies is also expected to see steady revenue growth with robust demand for its HVAC products and services.

2. Trane Technologies Margins Are Superior

Similar to the pattern seen in revenue growth, Trane Technologies’ operating margin of 14.4% over the last twelve month period is slightly better than the 10.0% for Johnson Controls, and it compares with 12.6% and 4.4% figures seen in 2019, before the pandemic, respectively. Even if we were to look at the last three fiscal year average operating margin, Trane Technologies’ 12% figure is better than 5% for Johnson Controls. Overall, for both the companies, margins are on the rise, but Trane Technologies’ current as well as historical operating margins have been better compared to Johnson Controls.

The Net of It All

Now that nearly 60% of the U.S. population is fully vaccinated against Covid-19, with overall economic activity picking up, the demand for non-residential building solutions is likely to rise going forward, boding well for Johnson Controls. Both the companies will benefit from continued HVAC demand.

That said, Covid-19 is proving more difficult to contain than initially thought, due to the spread of more contagious virus variants and infections in some of the geographies, including Europe, are higher than what they were a few months back. The concerns around Omicron has spooked the markets at large with several confirmed cases in the U.S., as well. If there is another large spike in Covid-19 cases from the new variant, it will disrupt economic recovery and impact sales as well as earnings growth of both the companies.

While Johnson Controls’ current valuation is surely more attractive than that of Trane Technologies, with JCI stock trading at about 2.3x trailing revenues, versus 3.3x for TT, the latter has demonstrated better revenue growth and it is more profitable. Not only that, even if we were to look at financial risk, Trane Technologies’ 11% debt as a percentage of its equity is better than 13% for Johnson Controls, and also, Trane Technologies’ 16% cash as percentage of assets is also better than the 3% figure for Johnson Controls, implying that TT has a better debt and cash position.

Overall, Trane Technologies trumps Johnson Controls in most of the metrics that matter for investors and we think this gap in valuation between the two companies is largely justified. In fact, looking forward, it is likely that the gap in valuation of these two companies will remain in the foreseeable future and Trane Technologies may continue to outperform with its better growth prospects and lower risk.

While TT stock may see higher levels, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Trane Technologies vs. Logitech.

Wondering how Johnson Controls peers stack up? Check out Johnson Controls Stock Comparison With Peers to see how JCI stock compares against peers on metrics that matter. You can find more such useful comparisons on Peer Comparisons.

What if you’re looking for a more balanced portfolio instead? Here’s a high-quality portfolio that’s beaten the market consistently since the end of 2016.

[1] Month-to-date and year-to-date as of 12/3/2021
[2] Cumulative total returns since 2017

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