There's little doubt that stock in building products company Johnson Controls (JCI 0.29%) looks like a good value. But can investors have confidence in a management that disappointed investors in the spring? In a sense, it's a classic investment conundrum: Take advantage of a value situation or avoid the stock until management restores confidence with investors. Here's the lowdown.
Johnson Controls, an ESG play
The company manufactures heating, ventilation, and air-conditioning (HVAC), building controls, and fire and security products and services. Its primary end market is commercial and institutional buildings. The investment case for the stock lies in the company's ability to help building owners improve the efficiency of their buildings using digital technology. Through its OpenBlue software platform and digital services, building owners/operators can amass data on building performance and use it to generate actionable insights to improve efficiency.
In addition, Johnson Controls' technology plays a crucial role in helping customers meet their net-zero carbon emission goals. Furthermore, its technology helps create healthy, clean, well-ventilated buildings -- a key concern after the outbreak of COVID-19. Combined, these elements give Johnson Controls some serious environmental, social, and governance (ESG) chops that make them a compelling investment that fits these investing criteria.
That's the long-term investment case for Johnson Controls; what about the near outlook for the stock?
A good valuation
Based on Wall Street analyst consensus and management's guidance, the stock looks like a good value. The company is currently trading in its fourth quarter of 2022, and investors hope it will meet management's guidance for full-year adjusted EPS of $2.98 to $3.02, representing year-over-year growth of 12% to 14%. The midpoint of the guidance would put the stock at less than 19 times 2022 earnings. Moreover, Wall Street expects strong growth in fiscal 2023, with the analyst consensus calling for EPS of $3.61 and free cash flow (FCF) of $2.54 billion. Those figures would put the stock at less than 16 times earnings and less than 15 times FCF in 2023 -- good value for such an attractive long-term growth stock.
The problem with Johnson Controls stock
Having started its fiscal year forecasting profit margin expansion and adjusted EPS of $3.22 to $3.32 for the full year, management was forced to cut its guidance to the range of $2.98 to $3.02 discussed above. The market didn't appreciate the cut. The guidance reduction also suggested management had previously been too optimistic about its ability to overcome supply chain difficulties and critical component shortages in 2022 -- not least with semiconductors and components for its higher-margin controls products.
As a result, investors put the stock in the doghouse, and management's credibility over guidance was questioned. Investors often take a "wait and see" approach in such situations. Combine this with the fear of a protracted economic slowdown hurting spending on buildings, and the stock's 30% decline this year is understandable.
Why Johnson Controls deserves the benefit of the doubt
That said, the company certainly isn't alone this year in suffering supply chain problems that are greater than initially expected. Moreover, end demand remains strong, with orders growing double digits and the company enjoying a record backlog. At some point, the supply chain problems will ease, and Johnson Controls will be better able to deliver on its backlog.
Further encouragement comes from the fact that rival building products technology company Honeywell (HON -0.09%) raised its guidance for full-year revenue growth in its building technologies (HBT) to double digits in July, having forecast high-single-digit growth at the start of the year. On the company's second-quarter earnings call, CFO Greg Lewis said that "supply chain constraints, particularly around semiconductors, have improved slightly each quarter so far" this year. HBT's backlog is up double digits on the year, and "energy efficiency and healthy building solutions remain a priority for our customers, enabling growth in our building solutions and healthy building businesses," according to Lewis.
It all points to an improving supply chain situation and a healthy end market. If that translates to Johnson Controls, it will likely meet analyst expectations. Therefore the stock is a good value, and investors should give management the benefit of the doubt.