The broader market's decline is creating buying opportunities in some high-quality growth stories, and I think Johnson Controls (JCI 1.02%) is one of them. The building products company has a combination of near-term solid growth potential and the stability of long-term growth prospects from its exposure to favorable megatrends in the economy. Here's the lowdown.
Introducing Johnson Controls
The company offers building products and solutions, primarily to the commercial buildings sector. Its portfolio of products and services includes heating, ventilation, and air conditioning (HVAC) and fire and security products, with a much smaller industrial refrigeration business. Within HVAC, Johnson is a much bigger player in the commercial HVAC market than in the residential market.
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Aside from valuation (I'll come back to that later), there are three key reasons to buy the stock:
- Management's financial targets to 2024 include a revenue compound annual growth rate (CAGR) of 6% to 7% and significant profit margin expansion leading to earnings per share (EPS) CAGR of 18% to 21%.
- Long-term growth prospects in its end markets come from the need for building owners to retrofit buildings to meet carbon emission aims and ensure clean, healthy facilities.
- The company can generate long-term growth from increasing adoption of digital technologies and smart building solutions.
As such, you can think of Johnson Controls as having exciting near-term growth prospects and have confidence in its long-term growth.
Growth to 2024
On the company's investor day in September, management said it is aiming for $500 million in cost savings by 2024 with $230 million coming in 2022 alone. For reference, Wall Street analysts believe Johnson will generate around $3.2 billion in operating profit in 2022.
A combination of cost savings and revenue growth leveraged into earnings growth is expected to propel the company to the 18% to 21% EPS CAGR target by 2024. Based on the current market cap of $47.4 billion and the Wall Street estimate above, that would put the company on a price to FCF multiple of 14.8 times FCF in 2024.
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That's a very attractive valuation, but what about the level of confidence in hitting that target, and what about growth prospects beyond 2024?
Long-term growth drivers
I think the answer to both questions above is a positive one. For example, management just released its first-quarter 2022 earnings and reaffirmed its fiscal 2022 EPS guidance of $3.22 to $3.32, implying a 22% to 25% increase year over year. Merely maintaining guidance was an impressive feat in itself after the significant cost pressures endured by the industrial sector. Supply chain disruptions and raw material prices rose significantly due to the resurgence of COVID-19 over the winter.
Due to rising costs, Johnson will see increased margin headwinds, but management expects a combination of solid end demand and price increases will result in earnings growth in line with its 2024 targets.
In addition, its orders and revenue are driven by some very powerful megatrends. The first comes from helping building owners meet their environmental goals and comply with building standards. For example, the building sector generates around 40% of global carbon dioxide emissions and improving building performance is a key part of the fight to decarbonize the economy. There's a massive opportunity for Johnson to play a leading role in the retrofitting of buildings to more efficient HVAC, security, and building controls. Meanwhile, the pandemic has created a heightened sense of awareness around the need for healthy, clean buildings with proper ventilation.
Underpinning the long-term demand from decarbonization and healthy buildings, Johnson has a huge opportunity from growth in smart, connected buildings. Through its OpenBlue software platform and digital capability, building owners can generate a mass of data to create actionable insights that improve performance. So it's not only about reducing carbon emissions; there's also a significant value-add in enhancing a building's efficiency.
As such, the value-add proposition from its digital offerings will help Johnson increase its attachment rate on its installed base of equipment. Attachments refer to service contracts attached to equipment sales. During the recent earnings call, CEO George Oliver emphasized that the company was going after its installed base to sell its OpenBlue digital services into it.
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A stock to buy
Given the compelling near- and long-term earnings drivers, Johnson Controls stock looks like a good value. A mature industrial company is often seen as a decent value at 20 times FCF and based on Wall Street analyst estimates, the stock will trade on slightly less than that at the end of 2022.
However, this is not a mature company with mid-single-digit growth prospects; it's in growth mode right now and has good long-term growth prospects. So, all told, I think the stock looks to be an excellent value right now.
