Johnson Controls: The Transformation Continues And The Dividend Increases 18%

| About: Johnson Controls (JCI)


Management is focused on transforming the company to increase profitability in the intermediate term.

Divesting of low-margin businesses and acquiring of higher-margin businesses should increase profitability.

The company recently raised their dividend 18 percent.

A rising dividend payout and substantial share repurchases will reward shareholders while waiting for the business transformation to lift profitability.

Johnson Controls (NYSE:JCI) has had mixed results with regard to their revenue growth, even though the company had shown operational improvements across all of their businesses. Given such circumstances, JCI's earnings growth is below that of their competitors', and, as such, the market is assigning a price-to-earnings multiple to JCI that is lower than the price-to-earnings ratio assigned to their competitors. The company, however, is in the midst of divesting lower-margin businesses and acquiring higher-margin businesses that will increase profitability in the intermediate term.

The company's shares currently yield about 2.10 percent as the company recently raised their dividend 18 percent. JCI's shares should strongly be considered for purchase as part of an investor's portfolio during the overall markets next 5 to 10 percent pullback. As recently as October 2014, during the overall market sell-off, JCI's shares dropped just below $40 and have since rebounded. As the company's ongoing transformation takes hold and becomes more appreciated by investors, the company's shares will be assigned a price to earnings ratio assigned to the company's competitors and the shares could rise to the low $60s in 18 to 24 months.


JCI is composed of three divisions. JCI's largest business division is its automotive division, which currently includes an interiors group, as well as seats, doors, and instrumentation panels. This division accounted for 51% of its 2013 revenue of $42.7 billion and 43% of its $3 billion in pretax income. The second-largest division of JCI is its building efficiencies division, which manufactures and services the infrastructure for forced-air heating and cooling in office buildings. This division accounts for 34% of 2013 revenue and 32% of pretax income. The third, the power solutions division, manufactures batteries, including standard lead car batteries and energy-efficient stop/start systems. The power solutions unit accounts for 15% of revenue and 33% of income. JCI management indicates that each division will account for essentially a third of overall revenues in the next few years.

Divestitures and acquisitions

Over the last few years, JCI has worked to exit its low-margin industrial businesses and move towards faster-growing markets or sub-markets and away from more capital-intensive and less-profitable markets. By selling off their auto-electronics unit and their garage-door-opening business and buying a company that makes heating and cooling and security systems for residential and commercial buildings, JCI exited two relatively small, capital-intensive businesses to enter a business that has margins nearly double its overall net margin. Through such actions, JCI is working towards managing its capital more efficiently and increase its earnings. More recently in May 2014, JCI announced its plan to spin off its low-margin, slow-growth auto interiors business into a joint venture with a division of the Chinese company SAIC. JCI will own 30 percent of the joint venture and receive an annual dividend as well. This spin-off into the joint venture changes the profile of JCI's interiors business from being a disadvantaged business that was in low-growth regions with a high cost base to a global company, whereby the spun-off joint venture has access to low-cost tooling, manufacturing equipment, and low-cost engineering skilled workers.

Fiscal fourth quarter 2014 earnings

In late October 2014, JCI announced adjusted earnings of $1.04 per share. Earnings increased 14.3 percent from 91 cents in the year-ago quarter. Including restructuring and non-recurring items, JCI's net income was $311 million or 46 cents per share.
 Revenues increased 2.6 percent from the year-ago quarter to $10.98 billion. Revenue growth across all of the company's divisions led to the revenue increase.
 The company's automotive experience division revenue increased 3 percent from the year-ago quarter to $5.3 billion. The company's building efficiency division revenues increased 1 percent from the year-ago quarter to $3.93 billion. The company's power solutions division revenue increased 5 percent to $1.8 billion from the year-ago quarter.

JCI announced the reorganization of their building efficiency division in their fiscal 2014 fourth quarter.
 The company announced their North American branch business of their building efficiency division will operate separately from the global products business. The company expects this action to be more profitable for their business. 
In addition, JCI announced that their plans to divest their global workplace solutions business. The company indicated they were taking such steps to invest in businesses that are core to their long-term growth and multi-industrial portfolio.

Fiscal year 2015 guidance

In early December 2014, JCI announced that they expected to earn record profits in their fiscal 2015. The company expects diluted earnings per share of approximately $3.55 to $3.70, excluding transaction and integration costs associated with their merger and acquisition activity, on consolidated net sales of approximately $42.3 billion, an amount flat in comparison with their fiscal 2014. The company expects sales increases in their building efficiency and power solutions divisions and profitability improvements in all three of their divisions. The company's automotive seating division 2015 sales are expected to decrease 5 to 6 percent. The company's power solutions division 2015 sales are expected to increase approximately 8 to 10 percent. The company's building efficiency division 2015 sales, excluding global workplace solutions, are expected to be up 9 to 11 percent.

Our view

JCI management is working to transform the company by exiting low-margin businesses and acquiring higher-margin businesses. This transformation is ongoing, and the results will become more appreciated by Wall Street and individual investors in the next 18 to 24 months. Many investors are failing to appreciate the divestitures and acquisitions JCI has been making recently to exit low-margin businesses and enter higher-margin businesses. Further, JCI's slow but steady transformation will capitalize on future trends, such as the energy-efficiency concerns of office tower owners and energy-efficient battery technology. JCI's present price to earnings ratio is 27.60. Earnings estimates for JCI are $3.62 for their current fiscal year 2015 and $4.15 for their fiscal year 2016. These earnings estimates have been falling over the last 3 months. JCI's shares are therefore trading at a forward price to earnings ratio of 13.70 based on fiscal year 2015 earnings estimates and 11.95 based on fiscal year 2016 earnings estimates. As JCI's margins increase, the company's forward price-to-earnings ratio should rise to a forward price-to-earnings ratio of 15. A price-to-earnings ratio of 15 is more in line with the price-to-earnings ratios of JCI's competitors: Emerson Electric (NYSE:EMR), Honeywell (NYSE:HON) and United Technologies (NYSE:UTX). As such, JCI's shares could reach a share price between $60 and $65 in about 18 to 24 months from now, given JCI's recent transformative actions. That said, with most stock market indexes at or near record highs, an individual investor might want to wait for JCI to drop to a share price between $42.50 and $47.50 to establish a full position. In fact, during the last overall market decline in October 2014, JCI's shares broke through the $40 level. Over the long term, JCI will reward investors with increasing dividends (as noted, a recent 18 percent increase), substantial share repurchases and a rising share price.

Disclosure: The author is long JCI, EMR, HON.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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