Johnson Controls (JCI) is a mid-cap industrial firm offering steady growth at a fair market valuation. Founded in 1883, JCI has a long history of earnings and dividend growth, fueled by a combination of acquisitions and organic growth.
WS Johnson, founder of JCI, is the father of multi-zone heating systems, inventing the multi-zone pneumatic control system. Called an electric tele-thermoscope, this system of multiple thermostats and heating/cooling zones is still a major component of JCI today.
JCI has expanded into a major worldwide player in the building and construction energy efficiency business, and the company continues to morph its business.
I first learned of JCI in 1985 when the company purchased a firm of which we owned stock. My bride’s grandfather had been on the Board of Directors of the Hoover Ball Bearing Company, which itself had morphed from manufacturing steel tanks and ball bearings in 1949 to automotive seats and interiors. At that time, JCI was a manufacturer of automotive batteries, looking to expand its auto OEM business. We owned some shares in Hoover and participated in the acquisition by JCI. I have owned JCI on and off since 1985, depending on college education tuition payment requirements. As all my kids have graduated and it’s not yet time for grandkids to suck me dry, I’m a current shareholder.
JCI continues to transform its business and has announced major restructuring over the past 12 months. JCI announced it was spinning off its auto interiors business while retaining its auto battery business, now called the “Power Segment”.
The interiors business accounted of 54% of 2015 revenues, making the split a substantial change in business profile. JCI recently sold some non-core auto assets and established a joint venture with Hitachi for others. JCI is pursuing a spin-off of its Automotive Experience business. Following the separation, which is expected to take effect in Oct 2016, the Automotive Experience business will operate as the independent, publicly traded company named Adient.
Management also announced it was merging with Tyco Int’l (TYC), a fire/security alarm system company, and plans to move its headquarters from Milwaukee to TYC’s home country of Ireland. TYCO offers home and commercial security and fire protection systems, and purchased the Brinks Security firm in 2011. Under the terms of the agreement, JCI shareholders are expected to own about 56 percent of business equity, and Tyco shareholders will own about 44 percent. The company will have annual revenues of $32 billion.
Tyco brings an active rolodex of over 3 million customers. Johnson Controls has a network of 15,000 heating and air conditioning service providers. The ability to cross-market security and fire protection programs with building energy efficiency platforms for heating and cooling is an intriguing opportunity. It is this cross-marketing that is driving the merger and refocus of JCI.
While auto OEM accounts for 25% of battery sales, the spin-off of Adient will greatly shift JCI’s customer risk away from concentric automotive trends to more ongoing building maintenance and construction. JCI should no longer be lumped together with low-growth automotive suppliers.
Being categorized as an auto supplier has hurt share values. According to Credit Suisse, the “new” JCI, with Tyco merged and Adient spun off, will improve valuations. The Building Efficiency, Power, and Tyco segments EBITDA could create share prices at 10.5 to 11.0 times while the auto Adient business could be valued as low as 4.5 times EBITDA.
According to Credit Suisse, JCI is currently worth about $50 a share, while it is trading at a price below $45. Several other analysts also have price targets in the $50 to $55 range, make the current share price undervalued by between 13% and 22%.
According to fastgraph.com, JCI has generate an 11.3% 20-yr average annual returns vs 6.9% for the S&P. However, over the previous 3 and 5 year time frames, JCI has underperformed and the automotive supplies sector has not been an erupting volcano of opportunity. With the spin-off of Adient and the merger with Tyco, better days should lie ahead for shareholders.
The restructuring and refocus of JCI comes with a higher execution risk. It is this risk that is creating uncertainty and a lower current valuation. The ongoing yield of 2.3% is not very exciting, but is more than offset by a 14% 5-yr dividend growth rate.
Investors looking for growth and income should take the time to review Johnson Controls. As the cloud of uncertainty lifts with increasing earnings growth and a successful cross-marketing campaign, JCI’s PE multiples should expand from its current 11 to a more reasonable 13 to 15.
This article first appeared in the July issue of Guiding Mast Investments. Thank you for your time and interest, George Fisher