A healthy bull vs. bear debate over Johnson Controls (JCI 1.02%) is happening. Since it makes sense to look at both sides of the argument before investing hard-earned money, I thought I'd consider what each side might argue over the stock before I draw any conclusions.
The bears' case for Johnson Controls stock
Johnson Controls organizes itself across two related activities. Its global-products business ($9.4 billion in sales in 2022) provides heating, ventilation, air conditioning, and refrigeration (HVACR) equipment, building controls, and fire and security systems to the applied (institutional, industrial, etc.), light commercial, and residential markets. Its other business is building solutions, which operates out of three geographically based segments that generated $15.9 billion in sales in 2022. It offers procurement and installation of HVACR equipment as well as related services.
There are two main bear arguments, and they are focused on the company's end markets. The first concerns its commercial construction exposure and its presence in the commercial office sector. It's no secret that office vacancy rates continue to rise, and there are question marks around an extended oversupply of office space given an increase in remote work over the last few years. At the same time, rising interest rates are putting pressure on commercial real estate debt holders.
Second, there are question marks around the sustainability of end demand, given the strength in orders last year. This is a common question in the industrial sector. Extended lead times for equipment (caused by the supply chain crisis and inability to procure critical components) led to customers bringing orders forward to try and ensure product. Given the improvement in the supply chain, Johnson Controls and other industrials may be about to see a drop in orders as customers adjust their behavior.
The bulls' case
In reply to the bear case, a glass-half-full viewpoint would argue the following:
- Johnson Controls does have exposure to the commercial office sector, but it's a relatively small part of its overall business.
- The company's growth in orders in 2023 already suggests that it has excellent momentum to overcome any pullback in orders.
- The company's underlying growth drivers are secular and will play out over the long term as they are tied to developments in digital technology and building owners' net-zero commitments.
Image source: Getty Images.
Limited exposure to the commercial office market
While the office market does immediately and easily spring to mind when considering the commercial HVACR sector, in reality, the sector includes much more than that, including retail, hospitality, banks, warehouses, entertainment, etc. Management developed this point on the last earnings call in early May, with CEO George Oliver saying of the office sector, "While Johnson Controls does have exposure to this sector, it represents a small portion of our overall business."
Wolfe Research analyst Nigel Coe suggested the company had "low single-digit exposure to commercial office new build" to which CFO Olivier Leonetti replied, "Your number is in the ballpark, Nigel."
Orders and backlog running hot
Investors were concerned when the company's trailing three-month field orders in its building-solutions business dipped to 5% year-over-year growth in its first quarter of 2023. Still, the second quarter saw a bounce back to 8%, driven by a 14% increase in service orders.
It's an impressive improvement, and a 13% increase in building solutions field sales led to a continuation of the improving trend in its backlog.
Data source: Johnson Controls presentations.
Whichever way you look at it, Johnson Controls has good order momentum and a solid backlog to support growth.
Long-term growth prospects
Management believes it has a long-term growth opportunity from a long cycle of retrofit upgrades from its installed base and new customers as building owners seek to meet their net-zero carbon-emissions goals by making their buildings more efficient. They can do this by utilizing the company's OpenBlue suite of digital applications and AI-driven technology to make buildings smarter and more productive.
In addition, internet-enabled digital technology is helping cut costs by making buildings more efficient and driving service revenue in the process.
Buy, sell, or hold?
Trading on 19 times expected earnings for 2023, Johnson Controls looks like a decent value for a company with solid long-term growth prospects. There are concerns about its commercial office exposure, but growth in other areas, such as data centers or infrastructure, can offset any weakness. As such, while the stock is unlikely to go to the moon, it should provide reasonable returns for investors in the coming years.
