There's No Better Time to Buy This Dividend Stock

Building products and systems company Johnson Controls' (JCI -0.25%) stock is down a whopping 42% so far in 2022. While it's never a good thing to see such a decline in such a short time, the drop is creating a buying opportunity for a company with a bright future. Here's a look at what's gone wrong so far in 2022, and why the stock presents a good value opportunity for dividend-seeking investors and value opportunists alike. 

Johnson Controls loses control

Johnson Controls is a leading player in the heating, ventilation, air conditioning, and refrigeration (HVACR) market, alongside offering fire & security products. And it's not just equipment; installation makes up 37% of the company's revenue, with service contributing 27%, and then equipment products at 36%.

The key to the investment case for the stock lies in three arguments:

• The increasing adoption of the company's digital offerings, which generate tangible improvements in building efficiency, will encourage a retrofit and upgrade cycle of spending. 
• Johnson Controls' solutions are crucial in helping building owners improve efficiency and reduce carbon emissions to reach their net-zero emissions targets. 
• The COVID-19 pandemic increased awareness around ensuring clean, healthy, and adequately ventilated buildings.

Management has sized the market opportunity from these factors at $250 billion over the next decade. That's on top of its existing market of $300 billion. 

That's exciting enough, but it gets even better when you consider what Wall Street analysts are expecting for earnings and free cash flow in the coming years. The table below shows consensus analyst estimates for earnings before interest, taxation, depreciation, and amortization, or EBITDA, and free cash flow (FCF) and some common valuations as well. Generally, an enterprise value (market cap plus net debt) to EBITDA of around 11 and a price-to-FCF multiple of 20 are seen as fair value.

As you can see in the table below, using the current market cap and price, Johnson Controls looks like it would be a very cheap stock at the end of 2023. Moreover, the current dividend yield is 2.8%, and based on its FCF estimates, the company will be able to pay a much bigger dividend in the coming years. 

Data source: marketscreener.com. Analysis by author.

What's been going wrong

While the above makes a compelling case, potential investors must reconcile themselves to the idea that the company's earnings forecasts are in doubt because management has already cut its full-year earnings and margin guidance. Although that cut is reflected in the analyst forecasts I used above, the reasons for the reduction might linger. In a nutshell, management was previously too optimistic about overcoming supply chain difficulties and component shortages (notably semiconductors). As such, the inability to ship products (particularly higher-margin products that include semiconductors) will negatively impact margin in 2022. 

So while orders growth remains strong (trailing three-month field orders are up 11%) and the backlog grew (up 12% year-over-year), management cut margin and earnings guidance for 2022. While those troubles could linger into 2023, management is optimistic. As the higher-margin products eventually get shipped, management believes it will start to see margin expansion in 2023. That's why earnings are expected to expand strongly in 2023. 

Is management too optimistic? 

Unfortunately, many of the issues creating the supply chain problems (lockdowns in China, war in Ukraine) have continued longer than expected, and it's reasonable to expect further pressure on Johnson Controls' business. Moreover, the global growth outlook has weakened in recent months. As a result, the margin recovery in fiscal 2023 (discussed above) is likely to happen, but it may be pushed out a bit further than the market anticipates. 

That said, Johnson Controls isn't alone in being caught out by lingering supply chain issues and the stock's valuation looks capable of withstanding some disappointment in earnings guidance in the current quarter. 

If you believe the economy will eventually work through the supply chain challenges and continue its jagged recovery, then there really isn't a better time to buy Johnson Controls stock. Just be aware that there's a near-term risk around its earnings guidance for 2022. Patience is required in turbulent markets.