Johnson Controls Still Reliable … In A Bad Way

When a company is described as "reliable," it's typically meant as a compliment. In the case of Johnson Controls (NYSE:JCI), however, reliability still means that you can usually expect this company to underwhelm. Although this remains a company that could be worth so much more with better financial results (and better management?), I find it difficult to argue for taking a chance on Johnson Controls absent a real path to better results.

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A Mixed Quarter to End the Year
Although Johnson Controls did report an EPS beat relative to analyst expectations, it would be a mistake to consider this a particularly strong quarter. What's more, the company's guidance for 2013 suggests another tough year in the making.

Revenue fell 4% this quarter, leading to a 4% miss relative to expectations. Building Efficiency was the worst on a reported basis (down 7%) and currency-adjusted basis (down 4%), while the auto and power businesses were more mixed. Auto revenue declined 2% as reported, but rose 3% in constant currency, while power was flat as reported and up 8% excluding currency and lead.

Johnson Controls' profits were not really a cause for celebration either. Gross margin declined about a half-point from last year. Operating income takes a little more explaining; while consolidated adjusted operating income rose about 48%, that's not the number that analysts follow.

Segment income is the more relevant number, and this fell 2% (missing average estimates just slightly). Power and Building Efficiency both showed stronger than expected margins (improving by more than two points and a quarter-point, respectively), but the larger auto business was substantially weaker than expected (3.2% margin against a 4.2% expectation). Consequently, Johnson Controls' beat was driven solely by below-the-line items such as taxes, making it a low-quality beat.

SEE: How To Decode A Company's Earnings Reports

Next Year Is Looking Tough
Johnson Controls not only issued lower guidance for 2013, but it was back end-loaded guidance as well. It looks like the first half of the year is going to be exceptionally weak, due in large part to Europe (about half of Johnson Controls' auto business comes from Europe), with some recovery in the second half.

It's a little challenging to reconcile some of this with what other companies have been saying. While Johnson Controls outperformed Honeywell (NYSE:HON) in vehicles (and underperformed in building controls), Honeywell didn't sound quite as cautious. Likewise, United Technologies (NYSE:UTX) did worse in building controls and wasn't exactly bubbling over with enthusiasm, but apparently isn't seeing the same near-term pressures.

SEE: Can Earnings Guidance Accurately Predict The Future?

Will this Restructuring do the Trick?
Although it is true that vehicle component manufacturers don't generally have good historical records when it comes to cash flow generation (for instance, companies such as American Axle (NYSE:AXL), Federal Mogul (Nasdaq:FDML) and Lear (NYSE:LEA) all have pretty poor records), Johnson Controls has never exactly made up for that with its other businesses.

Now the company is taking further actions (and charges) to restructure the business. Along with the usual moves (firing workers, closing plants), it sounds as though the company is also going to look to source more purchasing out of Eastern Europe. That makes ample sense, but I still think the company needs to go much further and fundamentally rethink how it approaches its businesses. Absent that, it's hard to get excited about the long-term cash flow generation potential.

The Bottom Line
Although Johnson Controls has a sizable auto parts business, I can't really see why an investor should own this company in favor of names such as BorgWarner (NYSE:BWA), Honeywell or other more promising names. Likewise, I see little in the Building Efficiency business that suggests leveragable long-term advantages over companies such as United Technologies, Honeywell or Siemens (NYSE:SI). And while the battery business (Power) probably has the most potential for game-changing technology or product developments, I'm not sure it can become large enough quickly enough to really change the trajectory of the company.

Maybe I'm too negative on Johnson Controls and too bearish on management's ability to drive changes. What I do know, however, is that even if the company can grow revenue at a mid-single digit rate and drive new highs in free cash flow margin in 2017 and beyond, the stock is still not attractively priced. Unless investors want to give Johnson Controls a low discount rate (which seems undeserved given its history of missing/lowering numbers) or project substantially higher sales growth (or free cash flow conversion), the shares just don't seem all that attractive today.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.