Johnson Controls Inc.
/ (JCI-NYSE)/ Equity Research / JCI | Page 3
Current Recommendation / NEUTRAL
Prior Recommendation / Outperform
Date of Last Change / 06/14/2011
Current Price (06/13/11) / $36.07
Target Price / $38.00
SUMMARY
Johnson Controls follows a strong cost-reduction strategy. The company expects to grow through meaningful acquisitions and increased capital expenditures. Its profit exceeded the Zacks Consensus Estimate in the most recent quarter by a penny. These factors have led the company to raise its sales and earnings forecast for full year 2011. However, pricing pressure from suppliers and tough competition are some of the concerns associated with the stock. In addition, the company’s deteriorated cash position may hinder its growth plans. Thus, we have downgraded our recommendation on the stock from Outperform to Neutral and set a target price of $38./ Equity Research / JCI | Page 3
SUMMARY DATA
52-Week High / $42.4052-Week Low / $26.53
One-Year Return (%) / 30.69
Beta / 1.82
Average Daily Volume (sh) / 4,348,823
Shares Outstanding (mil) / 678
Market Capitalization ($mil) / $24,472
Short Interest Ratio (days) / 1.13
Institutional Ownership (%) / 80
Insider Ownership (%) / 0
Annual Cash Dividend / $0.64
Dividend Yield (%) / 1.77
5-Yr. Historical Growth Rates
Sales (%) / 0.1
Earnings Per Share (%) / -5.4
Dividend (%) / 11.9
P/E using TTM EPS / 16.0
P/E using 2011 Estimate / 14.8
P/E using 2012 Estimate / 10.9
Zacks Rank *: Short Term
1 – 3 months outlook / 3 - Hold
* Definition / Disclosure on last page
Risk Level * / N/A,
Type of Stock / Large-Blend
Industry / Auto/Truck-Orig
Zacks Industry Rank * / 82 out of 291
OVERVIEW
Wisconsin-based Johnson Controls Inc. (JCI) is a supplier of automotive interiors, batteries, and other control equipment. The company functions through three segments: Automotive Experience, Building Efficiency and Power Solutions.
The Building Efficiency segment: This segment provides facility systems and services including comfort, energy and security management for the residential and non-residential buildings market. About 45% of building efficiency’s sales are derived from Heating, Ventilating and Air Conditioning (HVAC) products and installed control systems for construction and retrofit markets, of which 13% are related to new commercial construction. The rest are derived from its service offerings, including Global workplace solutions that provides on-site staff for complete real estate services, facility operation and management to improve the comfort, productivity, energy efficiency and cost effectiveness of building systems. The segment contributed 35% of the total revenue in the first half of fiscal 2011.
The Automotive Experience segment: This segment produces automotive interior systems for original equipment manufacturers (OEMs). This business comprises 65% seating and 35% interiors/electronics. The company generated 50% of the total revenue from this segment in the first half of fiscal 2011.
The Power Solutions segment: Globally, the Power Solutions segment is the largest manufacturer of lead acid automotive batteries and the most prominent developer of advanced battery chemistries. The segment constituted 15% of total sales in the first half of fiscal 2011. Nearly 77% of automotive battery sales are made to the auto aftermarket and 23% to OEMs.
Acquisitions and Joint Ventures
Over the last five years, Johnson Controls has acquired York International – the U.S.-based manufacturer of heating, ventilating, air-conditioning and refrigeration equipment and services; the global automotive battery business of U.S.-based auto parts manufacturer, Delphi Corporation; and Skymark International – a Canada-based manufacturer of indoor packaged HVAC products.
Johnson Controls formed a joint venture with the financiers of the bankrupt Plastech Engineered Products of Dearborn, Michigan, in which owns 70% having contributed $135 million in cash and 5 molding plants to the joint venture. The company also entered a joint venture with Saft Advanced Power Solutions and opened a lithium-ion automotive battery manufacturing facility in Nersac, France, which manufactures advanced lithium-ion batteries for hybrid, plug-in, fuel cell and electric vehicles.
REASONS TO BUY
Ø Johnson Controls’ constant focus on cost control not only increases production efficiency but also provides opportunities to drive margins over the next several years. Currently, the company pursues two restructuring plans: one initiated in September 2008 and the other in March 2009, which are expected to be completed by the end of 2011. Under the plan initiated in 2008, the company has experienced employee severance and termination benefit cash payouts of $95 million, of which $32 million were realized in fiscal 2010. Under the plan initiated in 2009, the company has experienced employee severance and termination benefit cash payouts of $70 million, of which $42 million were determined in fiscal 2010. Both plans included workforce reductions of approximately 20,400 employees. In addition, the 2008 and 2009 Plans included 33 plant closures, which were completed at the end of fiscal 2010.
Ø Johnson Controls’ battery business is set to grow from new hybrid wins, and the company is adding capacity to meet demand. The acquisition of the Delphi global battery business provides Johnson Controls with a stronger foothold. This business is set to improve due to new business wins for hybrids (whose content per vehicle is $1,000–$2,000 as opposed to $25 for gas-powered cars). The acquisition also enables Johnson Controls to participate in the rapidly growing Asian automotive battery market.
Ø Johnson Controls expects to benefit in the long-run from its focus on China. The company already owns 26 manufacturing plants catering to the automotive business in China. In the seating business, Johnson Controls has acquired more than 50% of the country’s market share. The company has started to invest $500 million in four automotive battery plants in and around Shanghai to meet excess demand in the country. The plants will have an annual production capacity of 30 million batteries by 2015.
Ø Johnson Controls anticipates revenues to increase 15% to $39.5 billion in fiscal 2011, up from the previous forecast of $38.5 billion. The increased guidance was driven by growth expectations for Building Efficiency and a stronger Euro.
REASONS TO SELL
Ø OEMs are continuously pressuring suppliers such as Johnson Controls to reduce prices due to their high inventory levels. This has led to a raw material/price squeeze. Further, volatility in commodity costs could hurt the company’s profitability. Commodities with high volatility in prices include steel, aluminum, copper and fuel in the Building Efficiency business and lead in the Power Solutions business.
Ø Johnson Controls faces strong competition from major domestic and international manufacturers and distributors of lead-acid batteries. The North American, European and Asian lead-acid battery markets are highly competitive.
Ø Johnson Controls’ cash position has deteriorated. In the first half of fiscal 2011, the company’s operating cash flow declined significantly to $168 million from $1.02 billion in the year-ago period, driven by higher inventories and accounts receivable. This apart, the company’s cash ratio fell significantly to 3.3% as of March 31, 2011 from 7.8% in the same period of the prior fiscal year.
Ø Johnson Controls’ debt has increased. Total debt rose to $4.54 billion as of March 31, 2011 from $3.38 billion in the corresponding period a year ago. Consequently, debt-to-capitalization ratio deteriorated to 29% from 26% a year ago.
RECENT NEWS
Johnson Controls Exceeds by a Penny – April 25, 2011
Johnson Controls Inc. reported a 31% increase in profit to $383 million (excluding non-recurring items) in the second quarter of fiscal 2011 from $292 million (excluding non-recurring items) in the same quarter of previous year. On earnings per share, profits improved 30% to $0.56 from $0.43 in the prior year, beating the Zacks Consensus Estimate by a penny.
The improvement in earnings during the quarter was attributable to higher sales on the back of the company’s strong position in the key geographic markets. Net sales in the quarter grew 22% to $10.14 billion, which was higher than the Zacks Consensus Estimate of $9.25 billion.
Segment Performance
Revenues in the Automotive Experience segment went up 25% to $5.22 billion, driven by higher production volumes and automotive seating and interior program launches. The company has completed 18 major launches during the quarter for Ford Motor Co., Kia, Volkswagen, Tata Motors, Daimler AG and Honda Motor Co.
The segment revenues in North America rose 22%, Europe increased 26% and Asia surged 37%, including a 31% rise in China. The segment reported an income of $247 million, a 31% increase from $189 million in the previous year quarter driven by higher volumes and improved operational efficiencies.
Revenues in the Building Efficiency segment escalated 18% to $3.52 billion led by a 31% rise in sales in Asia and a 27% increase in sales in Global Workplace Solutions. The segment had a backlog of $5.1 billion as of March 31, 2011, an increase of 18% over the prior year. The segment recorded a 27% rise in income to $132 million from $104 million driven by higher volumes.
Revenues in the Power Solutions segment appreciated 19% to $1.41 billion, reflecting higher shipments of both aftermarket and original equipment batteries. Aftermarket sales increased 17% in the Americas while original equipment (OE) and aftermarket unit sales in Asia jumped 163% due to higher volumes associated with the consolidation of a Korean joint venture, market share gains and incremental production from the company's second manufacturing plant in China.
The segment income soared 33% to $178 million from $134 million in the second quarter of fiscal 2010 as a result of the higher volumes and strong operational performance.
Financial Position
Johnson Controls had cash and cash equivalents of $401 million as of March 31, 2011 compared with $770 million in the year-ago period. Total debt amounted to $4.54 billion as of the above date compared with $3.38 billion a year ago. Consequently, debt-to-capitalization ratio deteriorated to 29% from 26% a year ago.
In the first half of fiscal 2011, Johnson Controls’ operating cash flow declined to $168 million from $1.02 billion in the year-ago period, driven by higher inventories and accounts receivable. Meanwhile, capital expenditures increased to $535 million from $311 million in the prior year.
Fiscal 2011 Guidance
Johnson Controls expects earnings to be affected by automotive production disruptions in Japan and at Japanese OE customers in North America and Europe during the upcoming quarter. It anticipates disruptions to negatively affect revenues by $500 million in the third quarter, which will lower earnings by $0.16–$0.18 per share. Taking this into account, the company expects to earn $0.51 to $0.53 per share in the third quarter of the fiscal year.
The company anticipates revenues to increase 15% to $39.5 billion in fiscal 2011, up from the previous forecast of $38.5 billion. The increased guidance was driven by growth expectations for Building Efficiency and a stronger Euro. However, higher Building Efficiency revenues will be partially offset by a negative impact associated with automotive production disruptions in Japan in the third quarter.
VALUATION
Currently, shares of Johnson Controls are trading at 14.8X our 2011 EPS estimate of $2.44. The company’s current trailing 12-month earnings multiple is 16.0, compared with 21.5, the average for the peer group, and 17.3 for the S&P 500. Over the last five years, shares of Johnson Controls have traded in a range of 6.3X to 64.4X trailing 12-month earnings. The stock is trading at a premium to the peer group, based on forward 2011 earnings estimates. The current P/E, which is in the lower quartile of the historical range, is at a 7% premium to the peer group for 2011. Our long-term Neutral recommendation on the stock indicates that it would perform in line with the market. Our $38 target price, 15.6X 2011 EPS, reflects this view.
Key Indicators
Earnings Surprise and Estimate Revision History
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DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of JCI. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts’ personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1023 companies covered: Outperform - 15.3%, Neutral - 78.0%, Underperform – 5.6%. Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company’s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock’s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.