Despite having declined nearly 9% year to date as of this writing, Johnson Controls' (NYSE:JCI) stock price has the potential to do much better for the rest of 2014. The three reasons I'll highlight include a specific end-market improvement, company restructuring, and exposure to an overall pickup in the economy. Altogether, it makes a powerful case for why Johnson Controls can rise from here.
As I discussed in my previous article, which outlines management's latest quarterly conference call, Johnson Controls is investing in acquisitions in order to expand its exposure to the heating, ventilation, and air conditioning, or HVAC, market via its building-efficiency segment. The company's other two segments are focused on the automotive industry. As such, building efficiency generated 29% of segmental income in the first nine months. However, investors can expect it to contribute more in the future following the $1.6 billion acquisition of HVAC-focused Air Distribution Technology, or ADT, and the announcement of a joint venture with Hitachi.
In addition, the ADT and Hitachi maneuvers show an effort to diversify away from Johnson Controls' core institutional HVAC market and into the commercial/industrial area. On this front, there are two positive things to look forward to. First, the commercial/industrial HVAC market tends to improve alongside the economy, and there are signs that U.S. growth will strengthen. Second, the institutional market appears to be picking up.
A quick look at the industry components in the Architecture Billings Index (a leading indicator of construction activity) confirms the recent pickup. A reading above 50 indicates expansion.
If the index is accurate, investors can expect an improvement in the HVAC market in the next year, and with the institutional market finally starting to improve, that should be good news for Johnson Controls.
Restructuring the automotive efficiency segment
The ongoing restructuring of the automotive efficiency segment (33% of segment income in the first nine months) continues apace, and readers can expect more benefits going forward. Income in the segment increased by 36% in the first nine months, with segmental income margin at 3.8% versus 3% for the same period last year. The margin improvement is part of the move to refocus the segment on its most profitable areas.
Moreover, the restructuring continues with the sale of its automotive electronics business to Visteon for $265 million and the creation of a joint venture with China's Yanfeng Automotive for its auto-interiors business. These moves will see the company focusing on its auto-seating business. This is good news, because the auto-interiors business actually lost $9 million in 2013, while the seating business (adjusting for a $476 million divestiture in electronics) contributed 88% of segmental income. The refocusing on seating will help management maximize profitability in the segment.
Power solutions pickup?
The power solutions segment manufactures car batteries, and as such, it's subject to demand from the aftermarket (around 75% of sales) and automotive manufacturers (25%). The case for improvement is simple: If the economy improves, then cars tend to get driven more, and if cars are driven more, then more car batteries will be bought.
For example, data from the U.S. Department of Transportation indicates that passenger miles for light-duty, short-wheel-base vehicles (i.e., cars) increased by 2.4% from 2009 to 2012. It's reasonable to expect that they will continue to do so in the near future, assuming an ongoing economic recovery.
All told, these three reasons indicate a mix of positive catalysts for Johnson Controls' share price, and investors should recognize the potential of this stock. The move to diversify away from the automotive sector is also a positive if you believe that diversification reduces risk. There is a lot to like about Johnson Controls, and with an improvement in the construction markets seemingly around the corner, the company looks set to reap the benefits of its investment in the industry.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.