Shares of Johnson Controls International plc (NYSE:JCI) have seen some operating momentum again as it has announced a bolt-on deal, enough of a reason to update a dated investment thesis which goes back to 2018.
At the time, I wondered if Johnson was making the right decision as it sold its Power Solutions business in a $13.2 billion deal. While the proceeds at first hand looked decent, and the company was simplifying the business, the company and its shares have been lagging for years, making me cautious with shares trading in the mid-thirties at the time.
Fast forwarding five years in time, shares have doubled on the back of a re-rating of the stock and some better margin performance.
A Recap
Johnson Controls sold the Power Solutions business to Brookfield back in 2018 in a $13.2 billion deal, with the headline number falling to $11.4 billion after taxes and deal-related costs.
The deal was set to create a pure player in building technologies and solutions in the HVAC industry, with $8 billion in sales leaving the door with the sale of the Power Solutions business, as $1.7 billion in EBITDA would walk out of the door as well.
The remaining $23.4 billion building business posted EBITDA margins around 13%. Adjusting for some buybacks, to avoid the dilution, the company could see pro forma earnings come in around $2.30 per share if the company would and could reduce the share count from 930 million shares to 683 million. This, however, required that $8.15 billion worth of stock would be bought back at $33 per share.
With shares trading at $33 per share, I believed that the company traded around 14-15 times earnings seen at $2.30 per share, while leverage ratios came in just over 2 times EBITDA, as this number excluded the underfunded status of pensions. The decision might have made sense from a positioning point of view, but the lower multiple for the sale and tax consequences were serious, making me not a buyer at the time.
Doing Well
After the announcement of the sale of the Power Solutions business, shares slipped to the $30 mark later in 2018, but recovered to $40 per share ahead of the pandemic. Shares rose in a huge manner in 2021 as the market priced in a big recovery, with shares having risen to $80 per share late in 2021.
What followed was a big pullback to the higher forties in 2022 as the market was pricing in a potential recession amidst a tough operating environment, including higher interest rates and inflation. Ever since, JCI shares have gradually recovered a bit, and now currently trading at $69 per share.
Forwarding to November 2022, Johnson Controls posted its results for the year with sales up nearly 7% to $25.3 billion, largely in line with the pro forma sales numbers in 2018. Share buybacks were executed upon as a share count of 689 million was largely similar to the share count assuming that the proceeds from the Power Business would entirely be earmarked for share buybacks. Adjusted earnings came in at $3.00 per share, ahead of the performance in 2018 with net debt reported at $6.9 billion, for a 1.9 times leverage ratio based on $3.7 billion in EBITDA.
Needless to say, valuations have expanded over time as the market likes the positioning of the business which includes a roughly $16 billion Building Solutions business which is largely tied to North America, and to a lesser extent EMEA, Latin America, and Asia Pacific. The remaining Global Products business is responsible for over $9 billion in sales derived from HVAC, refrigeration, and fire & security products. Despite an uncertain environment, the company outlined a 2023 earnings guidance with earnings seen at a midpoint of $3.40 per share, a number which was hiked to $3.45 per share upon the release of the first quarter results.
Second quarter results, as released in May, were even stronger, with reported sales up 10% as the company now sees 10% sales growth for the year and adjusted earnings at a midpoint of $3.55 per share. Net debt ticked up to $8.5 billion, although that trailing EBITDA improved to $3.9 billion, for a 2.2 times leverage ratio, mostly due to poor working capital management and some share buybacks.
Taking advantage of the greater operating momentum, Johnson Controls announced a deal to acquire workplace management software firm leader FM:Systems. The digital workplace management and IoT business was acquired for $455 million and will add technological expertise to transform, digitize and improve the efficiency of buildings, with no financial terms disclosed.
With 688 million shares of Johnson trading at $69 per share, the market value of the firm comes in at $47.5 billion, or about $51.4 billion if we factor in net debt. This means that the deal for FM:Systems is truly a bolt-on deal with a price tag of less than 1% of the prevailing enterprise valuation. The nature of the activities of FM:Systems most likely means that a higher valuation multiple has been paid, resulting in a small financial contribution, but with more strategic capabilities being added to the firm.
Concluding Thoughts
Following the strong guidance for 2023, shares of Johnson Controls trade at 19 times earnings, all while leverage is quite reasonable. This looks largely fair, but comes after a strong performance of the business this year, notably on the margin front.
The reality is that the positioning of healthier and greener buildings has certainly aided JCI shares here, but shares remain susceptible to volatility and economic cycles as well. After all, the shares saw a violent move higher in 2021 and a subsequent retreat in 2022.
This is remembered by me. While Johnson Controls International plc shares do see some momentum currently, I am a cautious but patient potential investor. I am watching for if shares retreat a bit (as this was a $55 stock in April), I am placing Johnson Controls International plc shares on my watch list, looking for a pullback to gradually enter a position in the higher fifties.
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