Johnson Controls: A Blue-Chip Suffering From Semiconductor Shortage

The commercial and industrial company has strong recent growth, but it is finding it hard to fill the backlog

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May 05, 2022
Summary
  • Johnson Controls manufactures and installs commercial and industrial HVAC and fire suppression systems.
  • The company has not procured enough semiconductors that is need for its advanced products.
  • Johnson Controls is selling near 52-week lows and has low forward valuation multiples.
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The global supply chain crisis doesn’t seem to be getting better for most companies. The latest victim is stalwart industrial company Johnson Controls Inc. (

JCI, Financial), a leading supplier of products and solutions for commercial buildings. The company manufactures, installs and services HVAC systems, building management systems and controls, industrial refrigeration systems and fire and security solutions.

Commercial HVAC in buildings and malls accounts for about 40% of sales, while fire and security systems represents another 40% of sales. Residential HVAC, industrial refrigeration and other solutions account for the remaining 20% of revenue.

In fiscal year 2020, the company launched its software platform, OpenBlue, which helps enterprises manage all aspects of their physical spaces by delivering sustainability, new tenant experiences, safety and security, combining the company’s building expertise with advanced technology. This includes AI-powered service solutions such as remote diagnostics, predictive maintenance, compliance monitoring and advanced risk assessments.

Johnson Controls has a history dating back to 1885. In 2016, Johnson Controls and Tyco completed a combination which joined Johnson's product portfolio of building efficiency solutions with Tyco’s portfolio of fire and security solutions. The company generated over $23.5 billion in revenue in 2021.

Second-quarter results

The results for the company’s fiscal second quarter ending March 31, 2021 where strong. However, guidance provided for the second half of the fiscal year was disappointing and below expectations.

Sales increased 9.0% organically while adjusted net income increased 18% over the prior-year period. Organic backlog growth increased 12%. However operating profit missed expectations due to the inability of the company to source semiconductors for its North American products, which are mostly high margin items.

The company stated these supply chain disruptions were worse than expected and continued to negatively impact the ability to convert backlog into sales. These margin and sales issues were also compounded by the China Covid-19 shutdowns and the Russia-Ukraine war.

This all negatively affected the company’s fiscal year guidance. It has now lowered earnings per share guidance to the $2.95 to $3.05 range, down from $3.22 to $3.32 previously. That is still an increase of 11% 15% over the prior year, but the pullback in expectations spooked investors.

The company typically generates strong free cash flow, and it currently has net debt of $7.68 billion. With nearly $4.0 billion in Ebitda expected this year, the company is not highly leveraged.

Valuation

The company will likely be under-earning it future potential capacity due to the supply chain and semiconductor issues mentioned above. Analyst EPS estimates for the current fiscal year ending in September have been reduced to approximately $3.00, which has the company selling at a forward price-earnings ratio of 18.

However, most analyst expects the semiconductor issues to alleviate after that. The EPS estimates for the year after are closer to $4.00, which I believe is a more reliable reference point. This represents a forward price-earnings ratio of 14, which is below the industry average, including competitors such as Honeywell (

HON, Financial) and Emerson Electric (EMR, Financial).

The company pays an annualized dividend of $1.40 which equates to a 2.50% yield at current levels. The payout ratio is still below 50% even on this year's depressed earnings.

Guru trades

Gurus who have purchased Johnson Controls stock recently include Chris Brandes and

Steven Cohen (Trades, Portfolio). Gurus who have reduced their Johnson Controls holdings include Ken Fisher (Trades, Portfolio) and Chris Davis (Trades, Portfolio).

Conclusion

Johnson Controls is now selling near 52-week lows, largely due to the semiconductor and supply chain issues, as well as current geopolitical conflict. The company appears to be undervalued on a forward-looking basis as the cost and supply chain issues are expected to be resolved over the next 12-18 months.

In a addition, with a market cap of only $38 billion and a stellar reputations in the industry, Johnson Controls could make a solid acquisition candidate for companies such as Honeywell or Berkshire-Hathaway (

BRK.B, Financial).

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Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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