Investors in Johnson Controls (JCI +1.62%) have watched their stock decline by nearly 14% this year, even as the company has outperformed expectations in one of its three segments (automotive experience) and made a host of initiatives to improve productivity. With that said, you might be wondering just why the company has declined in 2014. Let's take a look.
Source: Johnson Controls
Great Expectations
No, not a treatise on Charles Dickens, but a lead-in to what has happened this year with the company. Simply put, at the start of the year, investors had expected positive things from its three segments:
- Power solutions (automotive batteries) was expected to have a strong winter thanks to severe cold weather in North America.
- The building efficiency (heating, ventilation, and air-conditioning, or HVAC) segment was expected to see a pickup in demand from a long-anticipated improvement in North American construction activity.
- Automotive experience (car seating and interiors) looked set to have a good year as North America and China automotive sales and production looked likely to remain in growth mode.
Fast-forward to what actually happened, and it's a mixed story.
One out of three isn't enough
First, the power solutions segment did have a strong winter in North America, but just as cold weather increased demand for car batteries on one side of the pond, an unusually warm winter in Europe caused Johnson Controls' sales volumes to fall 15% in the region for the second quarter. In fact, the decline in Europe offset the 10% gain in the Americas, and led to overall sales being flat in power solutions in the second quarter.
Second, construction activity -- particularly in the company's core North American institutional market -- has disappointed many observers. A quick look at the Architecture Billings Index (a leading indicator of construction activity) reveals that the institutional index was in contraction for the first five months of the year -- a reading above 50 indicates growth.
On a more positive note, the indexes have perked up a bit lately -- particularly the institutional index -- and readers can learn about what management said about future prospects for the segment in a review of its conference call.
However, so far this year, investors have only seen the weakness in the first half represented within the company's results in the building efficiency segment.
Source: American Institute of Architects.
The good news is that the automotive experience segment has significantly outperformed expectations so far this year. Fools already know that the segment's revenue growth has been strong this year, thanks to relative outperformance by its customers -- especially with premium car manufacturers in Europe. Simply put, when Johnson Controls' customers are selling cars and upping production rates, the company will see increased demand.
Restructuring, acquisitions, and divestitures
The segmental performance outlined above is borne out by looking at EPS numbers versus expectations -- the company has missed expectations in two out of the three quarters this year. In addition, a lot of the company's most important activities this year have been in making initiatives involving restructuring the automotive-experience and building-efficiency segments. While these activities are laying the foundation for future earnings growth, they are also the sorts of things that a lot of short-term investors ignore. In other words, the market is unlikely to reward the company until the fruits of these initiatives show up in its earnings.
I've written previously in more detail on these initiatives. In short, the automotive experience segment has seen the sale of the automotive electronics unit, and the creation of a joint venture for its automotive interiors segment -- leaving management free to focus its efforts on seating. The building efficiency segment has been augmented by acquisitions intended to diversify its end markets away from the institutional market and toward the light commercial market.
All told, the company's setbacks in power solutions and building efficiency are partly a consequence of end markets that haven't been as strong as expectations would have demanded at the start of the year. Moreover, it doesn't appear to be getting too much credit for its restructuring activities, or for the outperformance of its automotive experience segment.
Going forward, if its construction markets improve and the restructuring activities pay off, then the current weakness could turn out to be a decent entry point into the stock.
