We launched Johnson Controls (NYSE: JCI) with a “Sell” rating, mostly based on valuation, in November 2021. Since then, stocks have underperformed the market by a factor of nearly 2, losing nearly 15% of their value. Meanwhile, the company has released strong results and we appreciate the financial guidance for FY22. We now think stocks are in buy territory, although they are still far from a bargain.
Johnson Controls announced a very solid fiscal first quarter, with sales up 8% organically, EPS up 26% and an EBITA margin improving by 30 basis points. The only disappointment was free cash flow, which was lower than the previous year due to increased capital expenditure and the absence of the Covid benefits of the previous year. The company also said it was on track to achieve approximately $230 million in productivity savings in FY22 and reaffirmed its guidance and outlook for the coming fiscal year. Another exciting news shared was the company’s inclusion in the Corporate Knights 2022 Global 100 Most Sustainable Corporations in the World ranking.
Looking at the company’s profit margins, we can see that the operating margin has improved and is now nearly 50% above its 5-year average. The productivity gains identified by management should further contribute to improving the operating margin, as well as the operating leverage resulting from the increase in sales.
The company continued its deleveraging. Last time we covered it, debt to EBITDA was around 2.3x, and now it’s closer to 2.1x.
Backlog continues to build and is currently 10% higher year over year, which should help the company continue to show sales growth in the coming quarters.
A big concern we had with Johnson Controls was its lower operating margin compared to its competitors, but the company has closed the gap and now has a higher operating margin than Carrier Global (CARR), and it approaches Trane Technologies (TT). This significant fundamental improvement is another reason why we are changing our rating on Johnson Controls to ‘Buy’.
Comparing the valuation multiples of these three companies, we find that they trade at similar values, with Trane Technologies imposing a small premium, which we consider reasonable given its superior profitability.
The valuation has improved significantly since we last covered the company thanks to a combination of a reduced share price and strong results generated by the company. We now believe that the shares are trading slightly below their intrinsic value and are therefore changing our rating to ‘Buy’. While we still don’t think the stocks are trading at a premium, we think they at least have a good chance of outperforming the market going forward. The company’s current EV/EBITDA multiple is around 13.9x, which is below its 5-year average of around 18.7x. Over the past five years, the cheapest price he traded was during the Covid crash, when shares were trading at around 11x EV/EBITDA.
The price-to-sales ratio has fallen from around 2.3x the last time we covered the company to around 1.8x now, much closer to the 5-year average of 1.6x.
Where investors may still be disappointed is with the dividend yield. We hope that the company will soon begin to increase it more significantly. The last increase was only about 3%. Right now, the dividend yield is still considerably below the 5-year average of 2.4%.
We find the current forward price/earnings multiple of around 19x much more reasonable. Looking ahead, the P/E ratio is compressing rapidly, with shares currently trading at just 14 times estimated earnings for FY24.
Guidance for exercise 22
Overall, guidance for FY2022 was very positive, with organic revenue trending towards an 8-10% increase, continued EBITA margin improvement of 50-60 bps and EPS in the $3.22 to $3.32, which would be a 22-25% increase. % increase year over year. The company is also moving toward approximately 100% free cash flow conversion from earnings, which will help with planned share buybacks of $1.4 billion and fund potential mergers and acquisitions.
Johnson Controls showed more improvement in its operations than we expected, at the same time as the shares fell, which now motivates us to readjust our rating to ‘Buy’. It is a quality company that will benefit from secular trends of global urbanization and increased demand for energy efficient, healthy and smart building products and solutions.