Summary
- JCI’s revenue in 2023 should benefit from the healthy backlog and pricing actions taken over the last few quarters.
- Margins should improve with the conversion of higher-priced backlog into revenue and through the implementation of productivity initiatives.
- Valuation looks attractive, given JCI's growth prospects.
Investment Thesis
Johnson Controls International (JCI) is benefiting from strong demand across its end markets, which has led to a buildup of a healthy order backlog. This is expected to drive sales growth in 2023. The company's pricing actions in recent quarters are also expected to support revenue growth in 2023, with management anticipating that pricing will contribute around 10% to organic growth. In the medium to long term, JCI is expected to benefit from projects related to the Inflation Reduction Act in the U.S. and Europe's new climate laws aimed at reducing greenhouse gas emissions by at least 55% by 2030. The company's margins are expected to improve from the conversion of the high-priced backlog into sales in 2023 and from productivity initiatives such as standardization and simplification of business processes. Given the positive growth prospects and a reasonable valuation, I rate the stock a buy.
JCI's Q1 FY23 Earnings
JCI recently reported a mixed first-quarter FY23 financial performance. The quarterly revenue of $6.07 billion was up 3.5% year-over-year but fell short of the consensus estimate of $6.25 billion. The adjusted EPS was $0.67, a 24% increase year-over-year, and met the consensus estimate. The revenue growth was driven by pricing (up 10% Y/Y) but partially offset by a 1% volume decline and a 6% currency headwind. The adjusted EBITA margin improved 140 basis points to 13.7%, due to positive price-cost dynamics and productivity improvements, but was partially offset by an unfavorable business mix. The improved margin and lower share count contributed to the adjusted EPS growth in the quarter.
While investors reacted negatively to the slight revenue miss, I believe the company has strong growth prospects in FY2023 and beyond and the post-earnings correction is a buying opportunity.
Revenue Outlook
The company saw good growth in order and backlog which should help FY23 revenue growth. In Q1 FY23, JCI's field business saw a 5% year-over-year increase in total orders, with install and service orders rising 1% and 10% respectively. The field business consists of the Building Solutions North America, Building Solutions EMEA/LA, and Building Solutions APAC segments. The backlog in the field business rose $800 mn year-over-year to $11.3 billion. The company's Global Product division, which includes equipment sold through third-party channels, experienced a significant 30% YoY growth in the third-party backlog.
Looking ahead, JCI is expected to continue to experience strong demand for its core business, including chillers, industrial refrigeration, and data center offerings. The company is working on expansion plans to support this demand and the robust order backlog from previous quarters. The pricing actions taken in 2022, along with the backlog, will likely drive sales growth in 2023. Despite moderation in inflationary pressure, the company aims to increase pricing in 2023 due to the strong value proposition of its offerings like the OpenBlue platform, which focuses on energy reduction, improved indoor environment quality, and autonomous building management. The OpenBlue platform enables businesses to manage all aspects of their physical spaces such as indoor air quality, security, etc. by combining JCI's products with technology and capabilities to enable data-driven "smart-building" services and solutions.
Management predicts that organic growth in 2023 will be in the range of high single-digits to low double-digits, with pricing expected to contribute approximately 10%.
Over the medium to long term, JCI is poised to benefit from initiatives related to the North American Inflation Reduction Act (IRA), which emphasizes electrification, increasing grid capacity, and energy efficiency. The company's heat pump technology and solutions around renewable energy present significant growth opportunities. Additionally, JCI should take advantage of the European climate law aimed at reducing net greenhouse gas emissions by at least 55% by 2030, as well as the REPowerEU plan which seeks to reduce dependency on Russian oil through the replacement of Russian fossil fuels with renewable energy.
Margin Outlook
In Q1 of FY23, the adjusted EBITA margin increased by 140 basis points to 13.7% due to favorable price-cost dynamics and productivity enhancements, partially offset by a less favorable business mix.
Looking forward, JCI's adjusted EBITA margin is expected to improve in 2023 as the company executes on its higher-margin backlog and benefits from productivity initiatives. The margins should also benefit from improvements in supply chain challenges and the expansion of the service business, which accounted for approximately 25% of total revenue in Q1 FY23. With these tailwinds, I am optimistic about margin improvement in 2023.
Valuation & Conclusion
JCI's stock is trading at a P/E ratio of 18.35x for its FY23 consensus earnings per share ((EPS)) of $3.50 and 16.50x for its FY24 consensus EPS of $4.02. The company has good revenue and EPS growth prospects, and if we look at the current consensus estimates, they are expecting mid-single-digit revenue growth and double-digit earnings growth for the next several years.
Given the strong growth prospects and an attractive valuation, I have a buy rating on the stock.
For further details see:
Johnson Controls: Post-Earnings Decline Is A Buying Opportunity