Monday, April 26, 2010

Johnson Control (NYSE:JCI): Upgrading to Outperform – Well Positioned for Cyclical Recovery - Baird

Baird is upgrading Johnson Control (NYSE:JCI) to Outperform from Neutral while raising their price target to $42 (prev. $33). Firm says JCI could be a $60 stock in 3-4 yrs time.

Firm notes that while they have been chasing the stock higher in recent months, it has outperformed the market by only 3% since its last earnings report and has been lagging the industrials sector of the S&P 500. This is one of the best business models in the automotive space with a well-diversified revenue steam across end markets and geographic regions. With automotive now less than one-half of revenue and one-fourth of profits, investors have increasingly viewed and valued the stock as an industrial.

The catalysts behind their upgrade are:

Rapid Profit Recovery: The company’s second fiscal quarter (March) was a record for any second quarter. Contributing to this was strong recovery in revenue, up 32%, driven by Interior Experience and Power Solutions along with parts of Building Efficiency (residential and Global Workplace Solutions). Additionally, margin recovery was significant driven by cost-cutting, volume and equity income from China in Interior Experience along with volume and productivity in Power Solutions and Building Efficiency.

Strong Growth in China: Strong economic activity in China is driving strong results across all business units; most of these investments are in minority-owned joint ventures with the profit growth most visible in the equity income line. Interior Experience is benefiting from the strong automotive demand and dominant market share. Power Solutions has a leading share of the OEM battery market and emerging end market demand bringing more advanced battery technology to this market. The Building Efficiency business is also well positioned.

Building Controls Business Is Turning the Corner: The company’s backlog for new systems in its Building Efficiency business is nearing an inflection point. Sequentially, the backlog starting to grow with year-over-year gains expected in the June quarter. The key drivers are increased award activity from stimulus money in the US and continued strong demand for energy efficient products and services.

Cyclical Recovery is Underway: The company’s automotive and building construction end markets appear to be at a trough in demand with multi-year cyclical recovery in revenue and profits likely.


Relative Stock Performance Lagging: The stock has had a great move off of the bottom. Baird notes they have been cautious about getting more aggressive on the stock in recent quarters. The combination of emerging signs of cyclical recovery, strong earnings performance and weak relative stock performance in recent months support the timing of their upgrade. The charts below show the stock as marginally outperformed the market since the last earnings report while underperforming the industrial sector of the S&P 500.

The company’s balance sheet and cash flow remain a key attraction to the stock. Net debt is now 22% of capital, well below the company’s target of 25-30%. This means there is about $1 billion in "dry powder” for acquisitions. Furthermore, Baird estimates the company could generate $3-4 billion in free cash flow (CFO less capital spending and dividends) over the next several years. The company has a very successful track record making acquisitions with a targeted 15 return on investment within the first couple of years. Putting this $4-5 billion in available funds into acquisitions could add $1.00 per share to firm's mid-cycle EPS estimate of $3.00-3.25 and $15-20 to their target price. Key areas for potential acquisitions are electronics in automotive, manufacturing capacity in batteries and product line/geographic extensions in building controls.

Notablecalls: Nice call, my only question is - will Baird have the power to move the stock? JCI traded 11 million shares on Friday.

Otherwise the chart looks good, close to breaking to new highs.

$35.50 is the line in the sand. It will get there but will it be surpassed?

1 comment:

Ryan said...
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