It always make sense to take a balanced viewpoint in investing, and while there are plenty of positive things happening at Johnson Controls Inc. (JCI 0.32%), there are also some negatives. The three things that investors need to worry about are its reliance on certain customer programs, the effects of weather, and the possibility of an unfavorable long-term trend with car usage. It's time to look a little closer at the bearish case for the stock.
Auto experience customers may disappoint
Before getting into the nitty-gritty, readers should note that this article is part of a series. The things that management wants you to know are outlined here, and the bullish case for Johnson Controls is here.
Focusing on the bearish case, investors should start by appreciating that the automotive experience segment, consisting of automotive seating and interiors, has outperformed most expectations this year. Going into the year, management had talked about 1%-2% revenue growth for the full year, but with 9% growth for the first nine months, it's likely to come in far in excess of expectations. Essentially, its customers' car sales have outperformed the marketplace, particularly in Europe. Indeed, CFO Bruce McDonald noted on the latest conference call that "we are able to exceed the market production levels in all three of the main regions."
This is an impressive performance, but investors need to ask themselves whether the market is baking in some expectations that can't be met in the future. Ultimately, the automotive experience segment relies on its customers' production levels, and there is no guarantee that its customers (it has heavy exposure to the premium end with customers such as BMW) will continue to outperform the market.
Power solutions and weather
Around three-quarters of the segmental sales in power solutions -- i.e., automotive batteries -- go to the automotive aftermarket. The biggest driver of growth in the aftermarket is wear and tear on automobiles. Essentially, a combination of driving miles (I'll return to this point later) and harsh weather causes automobiles to require maintenance and upkeep -- and this is when car batteries need to be replaced.
Source: Johnson Controls.
Indeed, one of the issues shareholders faced this year is that expectations were high for the power solutions segment following the harsh winter in many parts of North America. However, it was easy to forget that Europe had a very mild winter. In the end, power solutions came in with zero sales growth in the second quarter (which ended March 31), with Europe's 15% decline offsetting a 10% increase in the Americas. These points illustrate the fact that the segment's prospects are somewhat weather dependent, and investors should be mindful of the risk.
Long-term driving trends?
I noted in the bullish article that the amount of miles driven tends to correlate with economic growth. The miles-driven metric is important because it tends to drive aftermarket growth for car batteries. While the current situation is looking positive for Johnson Controls, as U.S. growth is picking up, there are some longer-term concerns that growth in miles driven may not pick up in the way many analysts think.
For example, the following chart of total vehicle miles traveled in the U.S. demonstrates how sluggish the pickup in vehicle miles driven has been since the 2008 recession. This could just be a reflection of moderate economic growth, or it may turn out to be something more systemic. If it's the latter, then automotive battery demand growth may not be what the company is traditionally used to, and analysts will have to reduce their estimated long-term growth rate for the power solutions segment -- not good news for the stock.
Source: U.S. Department of Transportation, Federal Highway Administration.
The takeaway
All told, these three reasons constitute different types of risk. The risk that the automotive experience segment's customers could underperform in the future is a company-specific issue. The weather risk is also an opportunity, but investors need to appreciate that any extreme weather will create uncertainty. For example, the market was expecting more from the power solutions segment this year, only to be disappointed.
The final reason is the most worrying, for Johnson Controls and the other companies servicing the automotive aftermarket. It's too early to tell whether there is a structural issue with growth in vehicle miles traveled in the U.S., so it's definitely something for investors to keep an eye out for.
