The irony behind the latest Johnson Controls' (NYSE:JCI) results is that they confirm the outperformance of its automotive activities, at a time when the company is investing on the construction side. Moreover, rivals like Ingersoll-Rand (NYSE:IR) and United Technologies (NYSE:UTX) also recently reported some moderate results in their heating, ventilation, and air conditioning, or HVAC, segments. With that said, does Johnson Controls' have some upside potential in the second half?
How Johnson Controls can outperform
The company reports out of three segments, of which readers can see the first nine months segmental income here.
The good news is each segment has upside potential for the rest of 2014:
- Automotive experience (automotive seating and interiors) can benefit from increased car production, particularly in North America and China.
- Power solutions (car batteries) has upside potential from stronger economic growth -- cars will get driven more.
- Building efficiency (HVAC solutions) will benefit from an improvement in global construction.
Johnson Controls automotive experience and power solutions
Alcoa's recent results confirmed that global automotive production remained on track. The planned spin-off of the lower-margin car interiors business into a joint venture with China's Yanfeng Automotive should allow Johnson Controls to focus on developing the seating business. China sales in the automotive experience segment were up 28% in the quarter and represented 32% of the segment's sales,and China has enacted some significant initiatives which could help boost sales of foreign cars. Looking longer term, Johnson Controls announced the award of new seat program for BMW, which is expected to contribute $325 million in annual revenue from 2017.So far in 2014, automotive experience has exceeded expectations, with sales up 9% (when the company had expected full-year sales to be up 1%-2% at the start of the year) and segmental income up 36% in the first nine months. Undoubtedly, car production has surprised on the upside in 2014, and a few recent indicators are suggesting that conditions could get better:
If automotive experience has outperformed, then power solutions has been slightly disappointing this year. In short, poor weather in North America encouraged the market to believe that battery demand (cold weather creates conditions where car batteries need to be replaced) would be stronger than it turned out to be. Investors seemed to forget that Europe's winter was mild, and battery demand (power solutions) turned out to be weak in the region.
Conversely, the automotive experience segment has seen Europe perform better than expected, the weakness in power solution in Europe dragged on into the latest quarter. Indeed, the third quarter's regional sales figures confirm this trend.
|Power Solutions||Unit Sales Growth|
With that said, sales were still up 6% and segment income increased 43%. Moreover, power solutions appears to be getting close to an inflexion point. Quoting from management on the conference call: "So we did see our European volumes toward the end of the quarter start to show some year-over-year improvement. So we are hopeful that the destocking is sort of behind us here."
Building efficiency, and what United Technologies and Ingersoll-Rand said
The building efficiency segment has been subject to the biggest disappointment this year, as the construction recovery continues to be prolonged. Indeed, although Ingersoll-Rand recently increased its full-year revenue guidance to 4% growth from 3%-4%, the change was really due to a better outlook in its industrial operations. Ingersoll-Rand now expects its full-year industrial sales to increase 2%-3% instead of 2% previously, but there was little change to its climate outlook.
It was a similar story with United Technologies' recent results, where its climate, controls, and security division saw its organic sales decline 1% in the quarter, partly due to U.S. residential destocking after a strong first quarter. For the second half of the year, United Technologies CFO, Gregory Hayes, discussed organic sales projections in the division by saying that the company is "expecting about 4%, so we've got a little bit of a hill here in the back half of the year"; yet again, a sustained recovery (if it occurs) in the commercial construction market has been delayed.
Turning to Johnson Controls, its management took great care not to proclaim a recovery just yet. Building efficiency sales were down 4% with segment income declining 3%. But management did outline that it saw some improvement in its pipelines:
What we are seeing for the first time is a couple of months of some larger projects in some of the institutional markets. ... I don't want to say the market is back, I am just saying that we are starting to see some good news which I haven't see in the past.
Putting these results and commentaries together, it's clear that the first half has disappointed in terms of the construction market, but the second half looks likely to be better.
Where next for Johnson Controls?
All told, the automotive experience segment is already performing well and for the reasons cited above, conditions are likely to get better in 2014. Similarly, power solutions could see an improvement in Europe in the second half. But the key upside surprise is likely to come from its building efficiency segment, even though the commentary is best described as cautiously optimistic. United Technologies and Ingersoll-Rand will also be hoping for an improvement, but Johnson Controls also offers upside potential from its automotive sectors.Well worth a look.