It was a tough fourth quarter for Johnson Controls Inc (JCI 2.56%) from an end-market perspective, but much of the bad news, such as the slowdown in China hitting its automotive and construction markets -- was arguably priced into the stock before the earnings came out.
The question now is what about the company's prospects in 2016? Let's take a look at the details behind the trends in the fourth quarter.
Johnson Controls' fourth quarter
The company's earnings can be summarized by the observation that management did a good job of generating margin increases in all three segments, even as end-market conditions deteriorated in each one.
Reported revenue fell 12% in the fourth quarter, but rose 3% when adjusted for foreign currency movements and the impact of the de-consolidation of the automotive interiors business. Segment margin expansion of 150 basis points (where 100 basis points equals 1%) helped reported segment income rise 3%, and 8% on a constant currency basis.
|
Revenue Growth |
Adjusted Revenue Growth |
Segment Income Growth |
Constant Currency Segment Income Growth |
Segment Margin Improvement (bp) | |
|---|---|---|---|---|---|
|
Building Efficiency |
Flat |
5% |
5% |
8% |
60 |
|
Automotive Experience |
-21% |
3% |
-1% |
4% |
120 |
|
Power Solution |
-6% |
3% |
5% |
11% |
200 |
Data source: Johnson Controls presentations. Automotive experience revenue includes de-consolidated interiors business.
Building Efficiency segment
Fourth-quarter year-over-year sales increased 5% in North America, but declined 7% in Asia on a reported basis -- and when adjusted for currency movements, Asia sales were flat. Management cited improved margin partly from a favorable price and mix of products. However, the real story is with orders.
For the fourth quarter, overall Building Efficiency orders declined 4%, with North American branch orders up 4%, Europe down 10%, and Asia declining 4%, but it's the whopping 37% decline in North America Federal Government orders that really catches the eye. On the earnings call, CEO Alex Molinaroli outlined that it all "actually really happened in the last week of September. Hopefully some of this work will come back over the next few months, and that assumes a constructive resolution in Congress around the federal budget."
In other words, there is no certainty the work will come back. The decline in orders caused backlog to decline 1%. This is a worrying sign, although Molinaroli outlined that backlog wasn't as good a predictor of future Building Efficiency sales, because the company has relatively increased its distribution sales.
In other words, relatively less of its sales are coming from project-related work that tends to show up in backlog. Nevertheless, its end market conditions definitely go worse for Building Efficiency in the quarter.
Automotive Experience
As you can see in the table above, organic growth came in at 3% in the quarter while industry production in both North America and Europe was up 5% in the same period. The real culprit was China, where industry production declined 5%. In fact, Johnson Controls outperformed the market by reporting a 3% underlying sales decline in China.
It's a narrative that was predicted by earlier results from aluminum supplier Alcoa Inc (AA +0.00%) when management lowered its full-year forecast for China automotive growth to 1% to 2% from a previous estimate of 5% to 8% growth. Interestingly, Alcoa raised its outlook for North America and EU automotive markets. Further color on the matter was given when auto-parts manufacturer BorgWarner (BWA 0.61%) disappointed the markets with its third-quarter results. BorgWarner's CEO James Verrier cited weaker conditions in China and commercial vehicle markets around the world.
All of this is particularly relevant to Johnson Controls because its focus is on the passenger car market, rather than commercial vehicles. According to Exec VP Bruce MacDonald on the earnings call, "We have very little content on the light commercial vehicles, so we are primarily exposed to the passenger car side. Many of our customers cut production in the quarter significantly more than sales, which led to inventory de-stocking." He went on to conclude: "I'm pretty optimistic that the worst is behind us here in China, and we're going to start to see modest to mid-single digit type growth."
If MacDonald's optimism is well placed, then Alcoa and BorgWarner could also benefit in future quarters.
Power Solutions
The margin improvement is impressive, although MacDonald cautioned investors that it wasn't sustainable: "We don't see our business continuing to sort of grow at that level." Clearly, Johnson Controls has a growth opportunity from its Absorbent Glass Mat, or AGM, batteries -- shipments up 44% in the quarter -- and the company is expanding capacity in order to meet surging demand.
On the other hand, overall original equipment automotive battery shipments only increased 2%, and aftermarket shipments increased just 1% in the quarter. Molinaroli responded to a question from Susquehanna analyst Robert Barry on the subject, arguing that it was difficult to predict when its customers would order batteries for the winter ahead and noted that his team saw 3% to 4% growth.
Looking ahead
All told, the story of the fourth quarter is good execution on margin within a difficult trading environment. However, in each segment, management alluded to a potential improvement in future quarters. Federal government orders could come back in Building Efficiency, while Automotive Experience may be past the worst of destocking in China, and aftermarket volumes in Power Solutions could pick up as customers build inventory for winter.
