HANOVER, GERMANY – MARCH 01: The logo of Johnson Controls stands over its production plant on March … [+]
[Updated: 5/17/2021] Johnson Control Update
Johnson Controls (NYSE: JCI) recently reported that it has completed the acquisition of Silent-Aire, a company focused on manufacturing and servicing of Modular Data Centers. Silent-Aire revenues for fiscal 2021 (ends in May) are estimated to be $650 million. [1]
Johnson Controls has been focused on energy efficient solutions for buildings and it has launched several new products for building automation, fire, and security. The company recently announced a 2MW community solar project in partnership with GRID Alternatives for the city of Pueblo, Colorado. The solar garden is expected to generate energy to meet the demand for 200 households, and help reduce the city’s carbon footprints. [2]
While the Covid-19 pandemic impacted the company’s sales in 2020, Johnson Controls has seen a rebound in demand of late. The company’s Q2 fiscal 2021 (fiscal ends in September) revenues grew 3% to $5.6 billion, and the company’s sales are estimated to trend higher over the coming quarters, led by a rebound in demand in the North America region. The U.S. is seeing a high vaccination rate and the economy is expected to see a rebound in growth, boding well for the non-residential construction, and in-turn demand for Johnson Controls products.
Although JCI stock has seen a large 3x move since the March 2020 lows of $23 and it appears richly valued based on 2021 expected earnings of $2.68 on a per share and adjusted basis, the stock may remain attractive for long-term investors, given the company’s focus on providing energy efficient building solutions and a lower carbon footprint. In fact, we believe that the entire renewable energy sector is likely to grow considerably over the coming years, driven by an increasing urgency to fight climate change and a more favorable regulatory environment in the U.S.
The U.S. has pledged to cut its greenhouse gas emissions in half by 2030, based on 2005 levels, while targeting net-zero emissions economy-wide by no later than 2050. Many other countries have also set similar long-term targets and this should result in a seismic shift in the $7 trillion global energy market, driving demand for renewable energy technologies. Our theme on Renewable Energy Stocks – which includes U.S.-based solar panel manufacturers, lithium miners, and hydrogen fuel cell producers – has significantly outperformed the market, returning about 139% since the end of 2019, compared to a return of 27% for the S&P 500.
[Updated: 3/31/2021] JCI Stock Update
Last month we discussed why Johnson Controls stock appeared to be fully valued. There have been multiple positive developments for the company since then. Earlier this month, the company announced an increase in share repurchase authorization by $4 billion, and it also raised its annual dividend to $1.08 per share from $1.04 per share earlier. Earlier this week, Dubai-based ODS Global, a building management service provider, entered into a strategic partnership with Johnson Controls in improving building operations, primarily focused on energy efficiency and digital transformation. Johnson Controls is one of the key players in the building automation market, which is expected to reach a valuation of $273 billion by 2023. Lastly, some of the analysts over the recent past have upgraded their ratings for JCI stock, citing multiple growth factors, including increased exposure to commercial buildings.
While these positives developments should bode well for JCI stock in the long-term, we continue to believe that JCI stock is overvalued at the current levels. The company reported revenues of $22.3 billion in 2020, reflecting a 12% drop from comparable revenues of $25.3 billion seen in 2018. Now, with the economic rebound following the containment of Covid-19 crisis, the sales for Johnson Controls are expected to improve. However, going by the consensus estimates, revenues are expected to be $23.3 billion in 2021, and $24.3 billion in 2022, implying that even by 2022, Johnson Controls will not reach the revenues it used to garner in the pre-Covid period. That said, margin expansion and share buybacks will surely help the company’s bottom line expansion, which is expected to grow to $2.96 per share in 2022, compared to $2.24 in 2020.
The stock has already appreciated a large 2.6x since its March 2020 lows, significantly outperforming the broader indices, with the S&P gaining 76% over the same period. The new variants of coronavirus have impacted the overall economic rebound in several countries, and Johnson Controls will likely see the impact on its non-residential buildings business. We maintain our view that JCI stock is richly valued, and it is now vulnerable to downside risk. Our dashboard, ’What Factors Drove 59% Growth In JCI Stock Between 2017 And Now’, has the underlying numbers.
[Updated: 2/25/2021] Buy Or Sell JCI Stock
After a 2.4x rise from its March 2020 lows, at the current price of $56 per share, we believe that Johnson Controls stock , appears to be fully valued. JCI stock has rallied from $23 to $56 off the March 2020 bottom compared to the S&P which moved 75%. While JCI stock has outperformed the market due to better than expected quarterly results, fewer project installations and lower demand for heating, ventilation, and air-conditioning continues to be a concern in the near term. Moreover, the stock is up 42% in the last one year despite revenue falling 8% y-o-y over the last four quarters. While the gradual opening up of the economy is expected to lead to higher demand for HVAC as well as building products, the stock appears to be richly valued when compared to its historical levels, making it vulnerable to downside risk. Our dashboard Buy Or Fear Johnson Controls Stock provides the key numbers behind our thinking.
JCI stock is also up 89% from the levels of $30 seen toward the end of 2018. Most of the stock price growth since 2018 can be attributed to the expansion of the company’s P/E multiple. Looking at fundamentals, total revenues declined 5% from $23.4 billion in fiscal 2018 to $22.3 billion in 2020, primarily due to the impact of Covid-19 on overall HVAC and building products demand. Furthermore, a 640 bps decline of net income margin due to increased costs during the pandemic, primarily SG&A, partly offset by a 19% drop in total shares outstanding, due to share repurchases, has meant that the company’s EPS declined 36% to $0.84 in 2020, compared to $2.34 in 2018.
Despite the company posting a decline in revenue and profits, the P/E multiple expanded from less than 4x in 2018 to 55x in 2020. The P/E multiple is currently at 66x, which we believe is high and compares with levels of under 16x seen in 2017 and 2018. Now, these numbers optically appear to be high, given these are based on GAAP earnings. But even if we were to look at the P/E multiple based on Non-GAAP earnings, JCI stock currently trades at 25x its trailing EPS of $2.24. The 25x figure compares with levels of around 20x seen in 2019 and 2020, making the stock vulnerable to downside risk.
Outlook
The coronavirus crisis induced lockdowns affected the real estate activity, primarily residential, and hit building solutions demand. The project timelines and cash flows for real estate developers were affected due to the halt in certain construction activities in 2020. Now with the economy gradually opening up, Johnson Controls’ business is also seeing an increase in demand. While the company reported a 4% drop in its top line in Q1 fiscal 2021, revenues were slightly above the consensus estimates. Also, the company’s net income margin grew from a little under 3% to over 6% over the same period, led by lower SG&A and lower restructuring costs.
Johnson Controls will likely see an increase in demand for its products in the near term, as non-residential building construction sees a rebound. That said, any further recovery in the economy and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Currently, investors seem to be buoyed by Johnson Control’s positive revenue and earnings outlook based on the expected recovery in the economic activity, and that appears to be priced in the current stock price of $56.
While Johnson Controls stock could see some correction, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Honeywell vs. Roper Industries.
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