Johnson Controls (JCI 3.13%) is an investing conundrum. It's not a company with a management team holding an excellent track record of meeting guidance. However, it is a good value stock in a highly attractive industry, and its 2.8% dividend yield makes it worth picking up on a dip for patient investors. Here's the how and why.
The long-term investment case for Johnson Controls
The company operates in four segments. The first is global products, which designs, manufactures, and sells heating, ventilation, air conditioning, and refrigeration (HVACR) products and software to the commercial and residential markets. It also sells controls and fire and security equipment. Global products sales tend to be made through dealers. Its crucial end markets are commercial HVAC (46% of 2023 segment sales) and fire and security products (37%).
NYSE: JCI
Key Data Points
The other three segments are building solutions in North America, building solutions in Asia Pacific, and building solutions in Europe, the Middle East, Africa, and Latin America (EMEA/LA). Building solutions designs, services, and installs HVAC equipment. Building solution sales tend to be made directly by the company.
The table below breaks out 2023 earnings so you can see the relative importance of each segment. The company's fiscal year ended Sept. 30.
|
Region |
Earnings Before Interest, Taxes, |
|---|---|
|
Global products |
$1,975 million |
|
Building solutions North America |
$1,394 million |
|
Building solutions EMEA/LA |
$316 million |
|
Building solutions Asia Pacific |
$343 million |
Data source: Johnson Controls. EBITA figures are adjusted, non-GAAP.
The key to the investment case lies in the massive opportunity to help building owners meet their net zero emissions goals by retrofitting toward the company's more efficient HVACR systems and controls. In addition, Johnson Controls' digital platform, OpenBlue, is driving an opportunity to upsell existing customers to its digital smart building solutions while growing higher-margin services sales.
What went wrong in 2023
It's a robust investment case, and the company has just finished its fiscal 2023, reporting organic sales growth of 8% and adjusted earnings per share (EPS) growth of 18%. So why is the stock down nearly 20% in 2023 as I write?
The answer lies in management overpromising and underdelivering rather than vice versa. On the third-quarter earnings call in August, management disappointed investors by lowering full-year organic sales growth estimates to "high single digits" from a prior estimate of 10%. Fast-forward to its delayed (due to a cyberattack affecting its business) fourth-quarter earnings report, and the company promptly missed its Q4 revenue and earnings guidance.
Image source: Getty Images.
While the cyberattack is unfortunate, it wasn't the only reason for the miss. For example, Q4 guidance was for organic sales growth of 4% and adjusted EPS of $1.10, but organic sales grew only 2%, and adjusted EPS was $1.05. For reference, management said the cyberattack shaved 1% off revenue growth and $0.04 off EPS in the quarter. Whichever way you look at it, Johnson Controls missed, and the market sold the stock off as analysts scrambled to lower price targets.
What about 2024?
Moreover, the first-quarter fiscal 2024 guidance (remember that we are almost at the end of the quarter already) is so weak that analysts questioned how the company would meet its full-year guidance.
| Metric |
Full Year 2023 |
Q1 2024 Guidance |
Full-Year 2024 Guidance |
|---|---|---|---|
|
Organic revenue growth |
8% |
Flat |
Mid-single digits |
|
Adjusted EPS |
$3.50 |
$0.48-$0.50 |
$3.65-$3.80 |
|
Free-cash-flow conversion from net income |
76% |
"seasonal usage" |
85% |
Data source: Johnson Controls.
Management is saying that its global products sales (down 2% organically in Q4) will, in the words of CFO Olivier Leonetti on the earnings call, "stabilize in the second half of 2024 as backlog continues to normalize and building solutions converts its higher-margin backlog."
Global products sales are weakening because dealers are reducing inventory as lead times improve. In other words, it's taking Johnson Controls less time to deliver products, so dealers no longer need to hold bloated inventory.
As for building solutions, orders growth improved to 9% in Q4. That's contributing to ongoing growth in the backlog that Leonetti refers to above.
Data source: Johnson Controls presentations.
A stock to buy?
The midpoint of management's full-year guidance puts the stock at 14.3 times earnings and less than 17 times free cash flow (FCF). Moreover, management believes it can improve its FCF conversion from net income over time to 100%. That would help increase its dividend payout as management aims to return all of its FCF to shareholders through share repurchases and dividends.
The valuations are attractive, and while there's weakness in China, residential HVAC, and global products destocking, the building solutions businesses continue to grow orders and backlog buoyed by solid demand from investment in semiconductors, electric vehicles, data centers, and healthcare facilities.
If the company hits management's guidance, it's an excellent value, but serious questions will be asked if it falls short. Investors' patience is running thin.
