Johnson Controls (NYSE:JCI) delivered an impressive set of first-quarter results last week, and investors must be feeling pretty good about the company's prospects in 2015. Indeed, Wall Street consensus for EPS growth is 13.2% in 2015, followed by 14.1% in 2016, even while revenue is expected to decline slightly in the period. In a nutshell, the investment case for Johnson Controls is based on its ability to restructure the company and generate margin expansion. In this context, let's look at five key takeaways from the recent earnings call, and see how management intends to generate growth. Is there more upside to come?
Power solutions segment normalizing
Before launching into the details, here is a quick look at segmental income in 2014.
The chart only tells part of the story, because the bulk of last year's growth came from building efficiency (mainly heating, ventilation and air conditioning, or HVAC, solutions) and automotive experience (car seating and interiors). Indeed, automotive experience and building efficiency contribute 44% and 46.7% of the growth in segmental income in the first quarter. Power solutions (automotive batteries) only contributed 9.3%, with the segment's income rising just 4%.
However, management indicated that power solutions growth could get a lot better in 2015. CEO Alex Molinaroli said, "Our aftermarket battery demand, it's really back to normal, not a new normal. Last year we had some real issues with volumes and this year we are really seeing things come back to what I would consider normal. Inventories are stable."
Some investors may recall that, in last year's second quarter, the company's car battery volumes were down 15% in Europe, as the region had a mild winter -- which helped to suppress demand -- but Vice-Chairman Bruce McDonald is expecting an improvement this year: "So in the quarter ... our volumes in Europe were up 7%. We expect to see upper single-digit for the next couple of quarters."
Automotive experience outperformance
The following chart shows the company's automotive experience sales growth versus its estimates for industry production. Net sales decreased 3% in the quarter, but if adjusted for currency, they were up 2%. Moreover, automotive experience segment income rose 26% due to a 110-basis-point (100 basis points equals 1%) increase in segment margin.
Readers will note that the company's North American sales underperformed the market in the last two quarters. According to McDonald, it's due to "seeing the impact of some of the business that is rolling off as a result of some of our quoting disciplines in the last year to 18 months." In other words, sales are likely being sacrificed for margin gains, and readers can see the benefit in the margin expansion discussed above.
Its Europe sales are outperforming due to its exposure to luxury car production. Moreover, its China sales are significantly outperforming. McDonald put this down to its exposure to vehicles positioned in three strongly growing submarkets within China's auto sector: SUVs, luxury vehicles, and European and North American manufacturers.
Building efficiency pipeline
There are strong reasons to suspect that the institutional construction market could improve notably in 2015, and Molinaroli outlined growing confidence in the company's prospects: "The reason that we are gaining confidence is if you look at the pipelines for the remainder of the year, you look at our Q2, our Q3 and our Q4, we're seeing a substantial increase in the pipeline."
Global Workplace Solutions divestiture
The fourth takeaway also relates to the building efficiency segment, where management intends to divest its facilities management business, Global Workplace Solutions, or GWS. The good news is that the plan appears to be on track. McDonald outlined that management was "really pleased with how it's going, strong buyer interest, very strong buyer interest. We expect that we will be in a position to announce who this business will be sold to probably in early Q3."
If you take GWS out of the building efficiency results for the first quarter, then the segment's margin would have been 6.7%, rather than 5.7% -- a pretty substantive increase.
Hitachi joint venture signed
Finally, management announced a definitive agreement with Hitachi to create a global HVAC joint venture. Essentially, Johnson Controls will acquire a 60% stake in Hitachi's global air-conditioning business.
According to Molinaroli, the joint venture will create the "largest commercial air-conditioning company in the world," and due to Hitachi's strong position in China, the joint venture would be the "number two player in China." Molinaroli also argued that the deal would close in the fourth quarter of 2015, and be accretive to EPS by $0.06-$0.07 (excluding transaction and integration costs) in 2016.
Molinaroli expects initial margin for the joint venture to be in the 4%-5% range, but he also suggested there was room for improvement since "margins are being dragged down quite a bit because of the residential part of their business and so that is an opportunity for improvement." Residential made up 47% of Hitachi's 2014 air-conditioning sales.
All told, these five takeaways show upside potential for each of Johnson Controls' segments, with ongoing restructuring activity and management's commitment to shifting to higher-margin businesses.
Lee Samaha has no position in any stocks mentioned, and thinks that there is far too much unnecessary jingoism on the subject of cars. Everyone should just accept that the Germans make the best cars. It's that simple.
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