Johnson Controls - Margin Expansion And Organic Sales Growth Are Future Growth Drivers

Investors in Johnson Controls (JCI) are hardly reacting to the company's outlined guidance for next year, and the strategic plans for the years ahead.

The company sees strong earnings growth, driven by margin expansion which on its turn is the result of the shift of focus away from the automotive sector to the power systems and building efficiency business. This should boost earnings growth and valuation multiples for the company going forward.

2014 Guidance

Last week, Johnson Controls released its outlook for 2014. Revenues for next year are expected to increase by some 3% to $43.8 billion, in line with consensus estimates of $43.87 billion.

The company does forecast strong income improvements with segment income seen up around 15% on the year before. This should translate in earnings seen between $3.15 and $3.30 per share. Analysts were projecting next year's earnings of $3.31 per share.

CEO Alex Molinaroli commented on the outlook for next year, "We are focused on market leadership in our core businesses and driving sustainable performance where we believe we can win. This is reflected in our expectations for a successful 2014 as well as the positive outlook we have provided through 2018. Johnson Controls has a heritage of consistent execution and innovation and today we will outline our plans to leverage that foundation to maximize shareholder value and continue to build our strategic position."

The company sees earnings growth in all segments which includes automotive experience, building efficiency and power solutions. The company aims to rebalance the portfolio to reduce the dependency on the auto sector, benefiting from higher valuations being awarded to other industries.

As a result, the company expects to remain active in terms of acquisitions and divestitures to mange the portfolio of businesses.

Mid-Term Outlook Till 2018

On top of next year's guidance, management gave a look into the expectations for the coming five years.

Automotive experience revenues are seen flat, excluding the non-consolidated joint ventures in China for the time period. Margins are expected to increase by 40-50 basis points to 7% of total revenues on the back of integration and cost improvements.

Power solutions revenues are seen up 8 to 9% on market share gains, growth in China and a better product mix. This strong sales growth should be accompanied by expanding margins to the tune of 100-150 basis points.

Growth in the building efficiency business is seen between 5 and 6% on growth and market share gains. Margins are seen peaking at 10% on volumes, price initiatives and supply chain gains.

Valuation

At the end of October, Johnson Controls released its fourth quarter results for the fiscal year of 2013.

The company ended the year with $1.05 billion in cash and equivalents. Total debt stands at $4.57 billion, resulting in a net debt position of $3.52 billion.

Annual revenues for 2013 came in at $42.73 billion, up 1.8% on the year before. Reported GAAP earnings were virtually unchanged at $1.18 billion.

Trading around $51 per share, the market values Johnson Controls at $34.5 billion. This values equity in the firm at 0.8 times annual revenues and 29 times GAAP earnings.

The quarterly dividend of $0.22 per share provides investors with an annual dividend yield of 1.7%.

Some Historical Perspective

Long term holders in Johnson Controls have seen excellent returns. Shares doubled between 2004 and 2007 to $40 per share. Shares saw quite a correction to $10 in 2009. Over the past year, shares have doubled from $25 at the end of 2012 to current all-time highs in the low fifties.

Between 2010 and 2013, the firm increased its annual revenues by a cumulative 25% to $42.7billion. Reported GAAP earnings fell by 10% at the same time to $1.18 billion.

Investment Thesis

Johnson Controls continues its aspirations to transform the diversified business into faster growing, and more profitable industries, thereby boosting the valuation of the entire company. Some crucial parts of this is the Johnson Controls Operating System, aligning processes within the entire company.

Sales growth partially comes from exposure to fast growing markets, but notably from China as well. The firm generates nearly a fifth of sales from China last year, a significant portion giving the company great exposure to growth. Growth is already witnessed in the fourth quarter results of 2013, when sales rose by 6% to little over $11 billion. At the same time, net income rose by 25% to $657 million, coming in at $0.95 per share.

Yet not all is good, as Johnson Controls continues to suffer from the volatility of the automotive sector which is now enjoying relative good times. For this reason alone, now seems the right timing to initiate portfolio rebalancing initiatives, notably in divestitures in the area.

Based on next year's projected earnings, Johnson Controls trades at 16 times earnings which seems fair given the projected margin expansion and revenue growth in the coming years ahead. Crucial to notice is the increased important of the power sales business and building efficiency, while the company aims to reduce the dependency on the automotive business.

Note that the power business reports margins of around 20% in the fourth quarter of 2013, while building efficiency margins are targeted at 10% for next year. This compares to margins of around 4% for the automotive business in the fourth quarter, which reports the smallest earnings of each of the three units. This is despite making up roughly half of total revenues.

Therefore the turnaround and strategic plan of the company is so important. A crucial example of these underperforming businesses is the interior business within automotive business, reporting a $13 million loss on $4.2 billion in sales. The company is exploring strategic options for the unit after selling the electronics business to Gentex (GNTX) in a $700 million deal earlier this year.

Despite the move away from the automotive business, Johnson will continue to operate within the industry, still being a core part of the business.

Investors applaud these value-creating moves, which are accompanied by greater shareholder payouts. The company recently hiked its quarterly dividend by nearly 16% to $0.22 per share, providing investors with a 1.7% dividend yield. On top of this came a new $3 billion share repurchase authorization, allowing the company to repurchase about 9% of its shares outstanding at current levels.

As such, it is notably margin expansions as well as organic revenue growth potential which should boost the value of the business. While this year's momentum has been strong, it is supported by the strong guidance and underlying performance. I applaud management decisions and remain optimistic about the firm's long term prospects given the development as outlined above.

Source: Johnson Controls - Margin Expansion And Organic Sales Growth Are Future Growth Drivers

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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