Johnson Controls (JCI) was pummeled after missing on fiscal third quarter earnings and reducing guidance. Shares closed Thursday at 26.07, down 8%. For investors who take a long term view, the shares are now attractively priced.
The company describes itself (in press releases) as follows:
Johnson Controls is a global diversified technology and industrial leader serving customers in more than 150 countries. Our 162,000 employees create quality products, services and solutions to optimize energy and operational efficiencies of buildings; lead-acid automotive batteries and advanced batteries for hybrid and electric vehicles; and interior systems for automobiles.
Two of the three sectors are automotive: the third is building related (HVAC). Approximately 25% of sales are automotive interiors in Europe. While the cyclical businesses and European exposure are of some concern in the present macro environment, I regard the company as high quality, and desirable as a long term holding.
Using estimates of $2.58 for 2013, and $2.56 for 2012, projected 5 year average EPS works out to $1.82 per share, influenced by a 61 cent loss in 2009 during the financial crisis. The company's midpoint multiple on that metric is 17.3, suggesting a target of $32 per share.
2009 is still visible in the rear view mirror, and visibility for 2013 is clouded by uncertainty. With long term growth in the 5% area, a multiple of 15 X $2.58 calls for $39 per share.
Assuming two years to hit the average of the two indications, annualized returns would be 19%, including the dividend, currently yielding 2.76%.
Johnson Controls has paid increasing dividends for many years. The company held them steady in 2009 and 2010: otherwise the trend has been for an annual increase. WIth a payout ratio of 28%, and strong cash flow, the dividend is secure. It yields 2.76% at a recent price of $26.07.
Johnson Controls will be revising its pension accounting to reflect mark-to-market valuations as of the end of the fiscal year. From the F3Q 2012 earnings conference call:
So if you really -- I guess really just putting this in perspective, for the last few years, we've kind of been on a path to insulate our financial results from the volatility of pensions and pension accounting. Some of the things that we've done, we've invested about $1.5 billion in discretionary pension contributions. We've closed and frozen the majority of our global defined-benefit plans, and we've adopted a number of more conservative investment strategies to derisk our investment returns, and so, you really need to look at this accounting change in light of all that. It's another step in that process.
In addition to the $1.5 billion in discretionary pension contributions mentioned above, the company during 2011 devoted $1.2 billion to acquisitions and $1.3 billion to capex. For 9 months of 2012, another $1.4 billion has been devoted to capex.
The size and timing of these investments is indicative of the strength of the company, and the skill of management. The automotive industry was under extreme pressure during the financial crisis. Coming out of that, the company was able to participate in the consolidation process and position itself to take advantage of the inevitable rebound, which has been developing favorably in North America.
Free cash flow will improve going forward, based on reduced capex.
Results for the fiscal third quarter were hurt by the increased cost of buying lead battery cores as feedstock for a new smelter that is going on line soon.
This is a temporary situation, brought about by a mild winter last year, which reduced demand for replacement batteries, and with that, the supply of cores for recycling.
The current heat wave is expected to stress batteries, resulting in a return to normal patterns and pricing during the current quarter.
The company faces headwinds and uncertainties arising from the slowdown in Europe, as well as fiscal and monetary policy in the US. The usual analyst day has been delayed from October this year, to allow the company time to assess the political environment and the possible decrease in GDP associated with the fiscal cliff.
Management expects to do some restructuring during the coming quarter, which will result in charges.
Presumably contingency plans will be in place in the event our politicians do something remarkably stupid. As an investor, the only comfort available is that management is prepared to act decisively to limit losses in the event of a politically induced economic slowdown.
A Long-term View on the Automotive Industry
There is considerable pent up demand for new automobiles, due to the aging of the American private passenger fleet. I discussed the issue at some length in an article on consumer deleveraging, and without going into details here, I'm bullish on automotive stocks, particularly large, high quality suppliers such as JCI or Magna International (MGA).
Strategy and Tactics
As discussed above, buying at today's prices, the investor has a reasonable expectation of receiving a steady flow of dividend income, with eventual share price appreciation.
As a general rule, the effects of an earnings miss stay in force until the next earnings report. Restructuring charges when the coming quarter is reported could result in a poor headline number and another leg down. Macro events may depress economic performance and stock prices.
Putting this through the blender, I'm planning to initiate a starter position during the coming quarter, with the idea of accumulating, monitoring and adding as the situation develops.