It's easy to dismiss Johnson Controls (NYSE:JCI) as just another play on global growth, but there is a lot more to investing in the company than you might first think. Its mix of automotive and construction end markets looks favorably set for growth, and the company is taking action to restructure two of its three segments. With that said, is Johnson Controls a buy?

Source: Johnson Controls.

Restructuring the automotive experience and building efficiency segments

Before reading more about Johnson Controls, you might want to check out a review of the key takeaways from the company's last earnings report, as well as a rundown of the bullish and bearish cases for the stock.

The company's core strength is in the automotive sector, with a mix of sales to car manufacturers (car seating and interiors, in its automotive experience segment) and the aftermarket (car batteries, in its power solutions segment). As discussed in the previous articles, the power solutions segment has performed worse than some had expected this year, partly due to a mild winter in Europe reducing aftermarket demand for batteries. Meanwhile, the automotive experience business has outperformed as a consequence of its customers exceeding expectations for sales and production.

The strongest investment case for the company is based on initiatives undertaken to restructure the automotive experience and building efficiency (heating, ventilation, and air conditioning, or HVAC) segments:

  • Sale of the final part of its automotive electronics business to Visteon for $265 million. 
  • Formation of a joint venture with China's Yanfeng Automotive Trim Systems, which means Johnson Controls will now focus on seating within its automotive experience segment. 
  • Acquisition of Air Distribution Technologies, or ADT, increases its exposure to the light commercial/industrial market and helps diversify the building efficiency segment away from its core institutional base.
  • Creation of a joint venture with Hitachi Appliances will add exposure to the light-medium commercial/industrial air conditioning market. 
  • The building efficiency segment is being reorganized with North American operations now managed separately from global operations.

In short, management is taking steps to increase growth at its automotive and building efficiency segments. Indeed, the company has already demonstrated the ability to generate margin growth and increased cash flow generation in the last two years.

JCI Operating Margin (TTM) data by YCharts.

What to expect in the future

It's clear that Johnson Controls has growth potential due to ongoing restructuring efforts and a pickup in its end markets. Going forward, management's opportunity is to increase the rate at which it converts earnings into free cash flow, and these initiatives are a key part of this objective.

Free cash flow is what really counts, because it's what a company can use to return cash to its shareholders. Unfortunately, the stock doesn't look like a great value when compared to peers in the automotive parts sector, such as Autoliv or TRW Automotive, or to a company with substantive HVAC exposure like Ingersoll-Rand.

The following chart compares these companies' enterprise value (market cap plus debt), or EV, to free cash flow.

JCI EV to Free Cash Flow (TTM) data by YCharts.

 Incidentally, the gap in the blue line is because Johnson Controls didn't generate any free cash flow in 2012 and  2013. However, the good news is that the company's growth prospects and restructuring activities are putting it in a position to increase earnings significantly, and to start converting more income to free cash flow. For example, the analyst consensus for Johnson Controls' earnings-per-share growth is 19% in 2014 and 16% in 2015.

The takeaway

The investment case for Johnson Controls is based on a combination of cyclical growth (ongoing strength in the automotive industry and a pickup in construction activity) and its internal restructuring plans.

While its valuation doesn't look cheap on the basis discussed above, readers should consider that management's forecast for free cash flow generation is $1.6 billion in 2014. If this figure increases in line with forecast EPS growth next year, then it could hit about $1.9 billion -- putting the stock on a forward EV/FCF valuation of 20 times. A quick look at the chart above reveals that this valuation would compare favorably with the current valuation of its peers. Throw in a 1.8% dividend yield and the possibility of upside surprise from an improving construction market, and the stock is attractive.