Based in Milwaukee, Wisconsin, Johnson Controls Inc. (JCI) is arguably one of the most diversified industrial firms in its sector and even in the S&P 500. Although JCI has struggled in the last two years on a pure net income basis, analyst optimism, strong fundamentals and valuation, and a rich dividend history make the company a great investment over the long run. It operates three main lines of business: the building efficiency segment, the automotive segment, and the power solutions segment.
The building efficiency segment is a $14.7 billion business that sells controls and services for heating, ventilation, and air conditioning systems. JCI has seen dwindling growth in the United States and Canada, but the firm is optimistic about growth opportunities in Asia, especially China. As you can see from JCI's financial statements, North America Systems and Service took a combined 5% hit in revenues. Income from these segments did increase by 16% and 36%, respectively, despite the revenue decline. This may be due to a greater emphasis on cost reduction. Revenues and income increased by 8% and 6%, respectively, and analysts expect this trend to continue as JCI focuses on growth in China.
|*In millions||2012 Sales||2011 Sales||Change||2012 Income||2011 Income||Change|
|North America Systems||$2,389||$2,343||2%||$286||$247||16%|
|North America Service||$2,145||$2,305||-7%||$164||$121||36%|
|Global Workplace Solutions||$4,294||$4,153||3%||$52||$22||*|
* Measure not meaningful according to JCI
JCI's automotive business recorded $21.3 billion in sales in 2012, making it the firm's largest segment. JCI is one of the market leaders in automotive seating and other interior products. I do not expect its competitors to take over JCI's market share or power any time soon. This position has been enhanced over the past several years due to acquiring other profitable businesses. North American and Asian revenues increased by double-digit figures from 2011 to 2012, while European revenues dropped by 3% due to lower demand. Furthermore, while North America and Asia saw much higher incomes in 2012, Europe posted a disappointing $52 million loss. This caused total segment income to only increase by 3%, which could have been much higher given better economic conditions in Europe.
|* In millions||2012 Sales||2011 Sales||Change||2012 Income||2011 Income||Change|
* Measure not meaningful according to JCI
Finally, JCI's smallest business segment is power solutions. This segment, which makes batteries, generated almost $6 billion in revenues. JCI is a leader in lead acid batteries used for vehicles and other applications, and this should not change in the near future. Most notably, this segment produced one of the first lithium-ion batteries for use in a vehicle. Revenues and income increased modestly by 1% and 4%, respectively. Company management believes that this increase was due to favorable pricing, product mix, and higher volumes.
|* In millions||2012||2011||Change|
To sum up the previous financial statements from each of JCI's well-diversified, market-leading businesses, the following table summarizes the pre-tax income in 2012.
|Building Efficiency||$ 910 M|
|Power Solutions||$ 854 M|
|Automotive||$ 803 M|
This data clearly shows the brilliance in JCI's business model. All three segments produce a significant amount of income relative to the company's entire pre-tax income. No segment produces more than 36% of total pre-tax income or no less than 31%. This tells me that management does a fantastic job at diversifying its entire business through three profitable business segments. Whereas some industrials may rely on one core business segment, Johnson Controls relies on three, and any major risk in one segment can be offset by opportunities in another. For example, weak automotive sales in Europe may be offset by strong Asian growth prospects in the building efficiency segment. This example has been a reality in the past year for Johnson Controls. The eurozone crisis has caused a decrease in demand for the automotive segment, while emerging markets, like China, are beginning to demand more "green" buildings.
Dividends - A Rich History!
Perhaps the most impressive aspect of Johnson Controls is its policy on dividends. The company has paid a dividend to its shareholders every year since 1887! It also increased the dividend every year from 1975 to 2008 and continued that increase in 2010 (not in 2009 because of the financial crisis). Therefore, JCI has shown me that it is a consistent dividend payer and will continue to be one in the future. The chart below illustrates the dividends per share from 1975 to 2013. This graph looks a lot like a staircase, indicative of a consistent increase in dividends.
Valuation and Equity Value
Johnson Controls is currently trading at $35.61. I believe that the firm is inherently worth more than its current price. With a market cap of about $24.4 billion, the firm is trading at a P/E of 14.94 times. However, I believe that the EV/EBITDA metric offers a more accurate representation of the firm's position, as it is independent of a company's capital structure.
JCI is trading at a 44% premium on an equity relative value basis. Taking this premium on the firm's current EV/EBITDA value of 6.2x, the implied EV/EBITDA value is 8.9x (6.2*1.44 = 8.9). Analysts project the forward 1-year EBITDA to be $3,782.5 M. This value multiplied by the implied EV/EBITDA value gives us an implied enterprise value of $33,759.6 M. Using the following formula, I will arrive at JCI's implied equity value.
|Enterprise Value||$ 33,759.6 M|
|+ Cash||+ $ 481 M|
|- Preferred & Other||- $ 439 M|
|- Total Debt||- $ 6,670 M|
|= Implied Equity Value||= $ 27,131.6 M|
JCI has 689.4 million shares outstanding. Thus, our equity value per share is $39.36, representing an 11% potential upside for the firm in the next year (not including dividends).
$27,131.6 M / 689.4 M = $39.36
Considering that analysts expect JCI's earnings per share to increase through 2014, I expect the firm to increase significantly in value over time. The following table shows analyst estimates for 2013 and 2014.
|Revenue||$ 41.96 B||$ 42.87 B||$ 45.28 B|
|Net Income||$ 1.23 B||$ 1.65 B||$ 2.19 B|
|EPS||$ 1.80||$ 2.40||$ 3.15|
Risks and Concerns
As mentioned previously, Europe remains one of JCI's major concerns, especially in the automotive business. More broadly speaking, the company is exposed to the cyclical auto industry. Demand has weakened in developed markets relative to emerging markets, so JCI needs to intensify its efforts in countries like China to make up for modest revenues in North America and Europe.
Company management is optimistic about its decision to become a major player in the lithium-ion battery industry, but I am concerned whether or not JCI will become one of the market leaders in this relatively untapped market.
Johnson Controls is a very well-diversified firm that offers an attractive dividend and capital gain investment opportunity. Its dividends are almost certain to increase every year, and I believe that the company will continue to post increasing earnings.
Company management forecasts weak demand in the second quarter of 2013, but it has the ability and confidence to grow earnings. Revenues in North America and Europe were soft in 2012, and yet the company still managed to increase earnings in all three segments. This suggests that the company is disciplined in nature and has appropriately acted upon soft revenue expectations by engaging in cost-cutting practices. Johnson Controls is a strong buy in my opinion over the long run.
Additional disclosure: All financial figures are from JCI's 2012 10-K form.