What’s Next For Johnson Controls Stock?

[Updated: 04/01/2021] JCI Stock Update

Last month we discussed why Johnson Controls stock (NYSE: JCI)  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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