Sergey Basalyga
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Sergey Basalyga in TX Group,

Johnson Controls: Separate Yet Successful

Introduction

Johnson Controls, Inc. (JСI), incorporated on July 31, 1900, manufactures, installs and services automatic temperature regulation systems for buildings. The company operates in three business segments, which include Building Efficiency, Automotive Experience and Power Solutions. The Building Efficiency business is engaged in designing, producing, marketing and installing heating, ventilating and air conditioning (HVAC) systems, building management systems, controls, security and mechanical equipment. The Automotive Experience business is an automotive supplier, providing interior systems through the company's design and engineering expertise. The Power Solutions business is a supplier of lead-acid automotive batteries for every type of passenger car, light truck and utility vehicle.

Performance

Johnson Controls is one of the top players in the market; at the same comparative analysis of the P/B and P/S multiples brilliantly shows that the company is undervalued relative to its peers group. P/E ratio is average yet higher than ones of Magna and Delphi.

Source: Table made by authors, based on data from Amigobulls

4th quarter of 2015 is expected to provide a good momentum to enter the following year and to bring earnings per share in Q1 of $0.80 to $0.83, which is up 8% to 12% from $0.74 last year.Source: Table made by authors, based on data from Amigobulls

Over the last month the shares have been traded above the average price, given the stable trading volume, and the shares price band has been narrowing. This is related to the traders’ and investors’ expectations of the Q3 conference held by the CEO of Johnson Controls Alex Molinaroli.

(Monthly volume of trade - mean and standard deviation)

Source: Made by authors, based on data from Investing.com

Business transformation

According to Molinaroli, Johnson Controls is making a strategic change towards a production and distribution business model, tightly connecting the Building Efficiency and Power Solutions divisions. JCI is concentrating on developing individual models and developing efficient manufacturing processes and supply chain management rather than maintaining a dependence on larger construction and infrastructure projects. The company is also making a concerted effort to bring more innovation into its products through both the Building Efficiency and Power Solutions divisions.

The recently launched lithium-ion distributed energy storage is a bright example of a technology that has been developed in the Power Solutions division and which will be distributed through the Building Efficiency division.

In the report Alex Molinaroli made it very clear that on the 1st of October 2016 the Automotive Experience division would be spun-off. More detailed information will be provided at Analyst Day in New York on the 1st of December. The market didn’t receive comprehensive information on the spin-off, hence we believe that until December 1st the shares will keep following the current trend as traders and investors are afraid of choosing a wrong position.

Source: Investing.com

We strongly believe that this spin-off will have positive influence on the shares price of JCI. As practice shows, parent companies tend to beat the market after breakups, though not as dramatically as spin-offs do.

In October 2011 Abbott Laboratories had announced the spin-off of AbbVie, which occurred in January 2013. Before this happened, the shares had increased only by 8%, but after the spin-off prices gained 25% over a year. The insignificant decline had been observed before the division due to investors’ worries over the future of the parent company. But right after the beginning of January the prices skyrocketed, gaining 38% (CAGR 12%).

The stocks created by corporate breakups also have rocky debuts, but many bounce back and outperform the market. When Abbott Laboratoriesspun off AbbVie, investors initially shunned it. Some saw AbbVie’s products as dead weight and unable to compete in the market (as it may happen with the ones of Johnson Controls´Automotive Experience).

Within a few months, though, AbbVie picked up steam. Its new arthritis drug, Humira, took off to become a global bestseller, which caused incredible price increase (90%, CAGR 24%).

Source: Yahoo Finance

Similarly, in March 2013, after ING Groep N.V. had announced the spin-off of Voya Financials, the shares of the parent company got a 22% increase, followed by the stable increase by 65% (CAGR 19%).

Source: Yahoo Finance

The shares of the spin-off company Voya Financials doubled the prices, showing CAGR 27%. Later on the prices had been increasing steadily.

Source: Yahoo Finance

Another example (in automotive industry) is recent increase of the Fiat Chrysler (FC) shares after had the Ferrari spun-off in October 204. The shares started showing healthy growth, moving from 10$ per share to 15,2$ per share right before the Ferrari IPO. More detailed information on this you can find in the article written by fellow bloggers .

Conclusion

We issue a BUY recommendation as the main investment decision ratios show that the shares are underpriced. Additionally, it´s highly probable that the price will increase significantly right before October 1, 2016.

Disclaimer

We are neither holding, nor planning to open any position. We are merely presenting our opinion, intended to be used in the WhoTrades Investment Strategy Contest.