The grim economic picture in Europe has slowed industrial activity on the continent and weighed down large multinational manufacturers. Growing sales from emerging economies haven't been enough to offset the slide. The ugly reality has hit conglomerates especially hard, which generally tolerate inefficiencies across their massive holdings. That is all about to change.
Johnson Controls (NYSE:JCI) is one such technology conglomerate scrambling to improve profitability in the face of European woes. The company's second-quarter earnings released this week could be summarized as "higher (financial metric) in (choose market) was partially/more than offset by lower (financial metric) in Europe". Shares have waddled sideways in the past five years, underperforming the S&P 500 by 18%. Will higher demand elsewhere be enough to shake off European worries?
Is the sky really falling?
Things are bad, but they may not be as bad as they seem. Despite the dismal state of affairs in the European theater, Johnson Controls has reaffirmed its earnings guidance for 2013. Already halfway through its fiscal year, expected EPS of $2.60-$2.70 is well above the $2.15 watermark set last year. Consolidation efforts and an increased focus on growth assets look to be paying off so far.
The company operates three key businesses: building efficiency, automotive experience, and power solutions. All were hit by declining European sales, although each had bright spots elsewhere. Building efficiency sales dropped 3% from the prior-year period, but gross profit grew 3%. The good news is that revenue will pick up in the second half of the fiscal year as the weather improves in North America and China and restructuring benefits take root.
Automotive experience didn't fare so well, which should come as no surprise to investors. Nearly all major automakers are struggling in Europe despite improving sales elsewhere. Ford (NYSE:F) lost $1.75 billion in the continent in 2012 and expects to see the red ink tally $2 billion this year. If automakers can't sell cars, then they have less incentive to build them. That hurts electronics technology companies such as Johnson Controls and explains big drops in auto-related income – even with Chinese sales soaring 31%.
Power solutions grew sales 10% to $1.6 billion and income 11% compared to the prior-year period. The segment made up 15.4% of total revenue for the quarter, which should grow in coming years. The company completed the ramp-up of its automotive battery recycling facility and is on pace to complete its second battery factory in China.
One thing to remember is that Johnson Controls isn't the only conglomerate struggling on the continent. Honeywell (NYSE:HON), which competes with the company's building efficiency business, has been hurt by weak industrial demand there as well. The company has also been forced to restructure core businesses and focus on growth markets. A successful first quarter helped Honeywell boost guidance and approach 52-week highs, while Johnson simply met expectations. Darn.
Major global auto suppliers Magna International (NYSE:MGA) and Lear Corporation (NYSE:LEA) have been obvious targets for a depressed European market. Both companies cited a 6% slide in Old World auto production in 2012 as the dominating factor keeping sales revenue down. Meanwhile, production in North America and China were up 17% and 7%, respectively. The pleasant pickup in production and the reemergence of the American automobile industry has aided auto sales for the two companies. That and a focus on non-auto markets has led each company to its best earnings in years.
Foolish bottom line
Will Johnson Controls be able to shake the dead weight from Europe? It doesn't look like that will happen any time soon, but it may not matter. Sure, it only met expectations in its most recent quarter. But if Magna and Lear can profit from the worldwide auto market, then the company should be able to meet its efficiency targets. Looking around the industry shows that two things are more important than slowing industrial activity in the Old World: diversification and growth markets. Good news for investors: Johnson Controls is cruising in both categories.