It’s hot out there – and
Johnson Controls International
is a company whose stock can benefit by helping people cool down.
The US is raging in a heatwave at the start of summer, with temperatures in Portland, Oregon, for example, hitting a record 116 degrees in the past week. It can be miserable for those stuck outside, but it’s good for companies that make and maintain heating, ventilation and air conditioning systems.
As heat waves come and go, the demand to keep employees cool when they return to the office, coupled with the need to do so in the most efficient way, creates an opportunity for heating, ventilation and air conditioning, or HVAC, companies after the temperature has normalized. With faster growth but a cheaper valuation than some competitors, Johnson Controls (ticker: JCI) looks set to continue its rally.
HVAC systems aren’t Johnson Controls’ only business, but it’s a big one. Founded in 1885, the modern version of the company began to take shape in 2016, when it merged with
The combined company continued to adapt its business portfolio and sold its power solutions business in 2019. This left Johnson with a portfolio of companies that meet the needs of commercial building operators for fire protection and security, as well as heating and cooling. The Ireland-based company, with its North American headquarters in Milwaukee, now considers itself a supplier of smart buildings. HVAC and industrial refrigeration account for about 60% of sales; the rest comes from fire and safety.
Beyond the heat wave, there is a larger longer-term trend that could increase demand for Johnson’s Controls stock: the return of workers to offices. Office occupancy is critical to the business: Johnson Controls suffered a 7% drop in revenue in the fiscal year ended September 2020, to $22.3 billion, when many offices around the world were vacant.
With workers returning, with vaccination rates soaring and an increase in overall economic activity, a new focus on air quality has become a major tailwind for the entire HVAC industry. An investigation conducted by
(HON), another smart building solutions provider, says Covid-19 has pushed 75% of building managers to permanently change business practices, with 60% more likely to invest in air quality.
Companies don’t just try to keep their employees cool. They also try to reduce CO2 emissions. An important way to reduce emissions is to operate buildings more efficiently. For example, air conditioning consumes about 20% of buildings’ electricity consumption. And electricity generation systems are responsible for about 25% of all greenhouse gas emissions worldwide. The air conditioning math also does not take into account the emissions from heating buildings in colder months. Put it all together and George Oliver, CEO of Johnson, says, “Buildings represent 40% of the global carbon footprint.”
Johnson can make buildings more efficient with new hardware, but software also plays an increasingly important role. The company recently partnered with
(MSFT) to build smart building solutions to reduce waste. The partnership essentially takes the data from all the devices running commercial buildings and puts it in the cloud.
Wall Street is seeing Johnson’s revenue grow at an average of 5.4% per year from fiscal year 2021 to 2023, outpacing revenue growth from peers. In addition, operating profit margins are expected to increase by approximately two percentage points, from approximately 11% to 13%. More margin expansion is possible in the future. Johnson’s margins, stemming from its multi-year business transformation, are still below the 15% to 16% typical of other major HVAC companies, including
“There is much more” [that Johnson] can do to rationalize their field sales,” said RBC Capital Markets analyst Deane Dray. “The new digital monitoring initiative has much higher margins and indoor air quality should be a multi-year windfall for the entire industry.”
Digital sales and improved profit margins mean faster profit growth than comparable companies. Johnson’s earnings per share are expected to grow at an average rate of about 19% per year between 2021 and 2023. That’s about seven percentage points better than Carrier and Trane. The combination of revenue growth and margin improvement is why Barclays analyst Julian Mitchell upgraded Johnson shares from Hold to Overweight in May. Its price target for the stock is $75, up about 10% from a recent level of $68.50.
Johnson Controls, with a market cap of nearly $50 billion, does have risks. The company is indebted to 2.9 times the remaining 12-month earnings before interest, taxes, depreciation and amortization, or Ebitda, giving it more leverage than its competitors. That’s a reason for investor conservatism, but the total debt is not in line with that of other industrial conglomerates, which average about 1.5 to twice as high. If Johnson can trade closer to his competitors, at perhaps 25 times earnings, shares could hit about $86 by mid-2022, up about 25% from recent levels.
That’s the kind of hot stock returns every investor should love.
Write to Al Root at [email protected]