Johnson Controls Is Undervalued: Merger & Spin-Off Are Catalyst - Sure Dividend Sure Dividend

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Johnson Controls Is Undervalued: Merger & Spin-Off Are Catalyst

Published June 15th, 2016 by Arie Goren

After successful 130 years of operations, Johnson Controls (JCI) is transforming to become a leading global multi-industrial company, by a mega-merger with Tyco (TYC), and spinning off its automotive seating and interiors business to a new publicly traded company to be named Adient.

Johnson Controls is a global multi-industry company that provides heating, ventilation, and air-conditioning, and other mechanical systems for buildings, lead-acid and advanced batteries for automobiles, and automotive interior systems.

The company also provides technical services, an energy management consulting, and operational support for the entire real estate portfolios for the non-residential buildings market. It also provides industrial refrigeration products.

Johnson Controls ranks as a ‘Buy’ using The 8 Rules of Dividend Investing.  This article takes a detailed look at the favorable risk/reward characteristics and current events of Johnson Controls.

You can download a free 2 page PDF summary of Johnson Controls straight from the Sure Dividend newsletter by clicking here, including long-term historical dividend yield, competitive advantage, and fair value.

Recent Results

On April 21, Johnson Controls reported its second quarter fiscal 2016 financial results, which beat adjusted earnings-per-share expectations by $0.04 (4.9%).  Johnson Controls has shown earnings-per-share surprise in two of its last four quarters meeting estimates in the other two quarters, as shown in the table below.

Johnson Controls Earnings Surprise

Data: Yahoo Finance

The company posted revenues of $9.03 billion, down 1.8% year over year, missing consensus estimate of $9.08 billion.  Diluted earnings-per-share surged 18%.

Johnson Controls 2nd Quarter Earnings

Source: Second Quarter 2016 Earnings Conference Call

In the report, Alex Molinaroli, Johnson Controls chairman, president and chief executive officer, said:

“I could not be more proud of the continued execution by our team. This quarter we drove organic growth in each of our businesses while delivering significant margin expansion. Automotive Experience generated record profitability while our China investments in Power Solutions resulted in record battery shipments in the region. In Building Efficiency, the Johnson Controls-Hitachi joint venture is exceeding our expectations and we continue to see positive momentum in our Systems and Services North America business with 9 percent organic revenue growth in the quarter. As we continue through this historic transformation, we are serving our customers and consistently delivering long-term shareholder value.”

Johnson Controls also raised its full year fiscal 2016 guidance from $3.70 – $3.90 to $3.85 – $4.00 reflecting stronger operational performance and a reduction of the company’s annual effective tax rate from 19% percent to 17%. According to the company, it expects 2016 fiscal third quarter earnings per diluted share of $1.01 – $1.04.

Johnson Controls 2016 Guidance

Source: Second Quarter 2016 Earnings Conference Call

Johnson Controls and Tyco Merger

On January 25, Johnson Controls and Tyco announced that they have entered into a definitive merger agreement under which Johnson Controls, a global multi-industrial company, will combine with Tyco, a global fire and security provider, to create the leader in building products and technology, integrated solutions and energy storage.

Under the terms of the agreement, which has been unanimously approved by both companies’ Boards of Directors, Johnson Controls shareholders will own approximately 56% of the equity of the combined company and receive aggregate cash consideration of approximately $3.9 billion. Current Tyco shareholders will own approximately 44% of the equity of the combined company. CEO Molinaroli explained:

“The proposed combination of Johnson Controls and Tyco represents the next phase of our transformation to become a leading global multi-industrial company. With its world-class fire and security businesses, Tyco aligns with and enhances the Johnson Controls buildings platform and further positions all of our businesses for global growth. Through this transaction, we will also expand our ability to further invest globally, develop new innovative solutions for customers and return capital to shareholders.”

The merger with Tyco will bring Johnson Controls a significant tax benefit Since the merger will make Johnson Controls an Irish company. Spinning off Adient afterward will allow it to be immediately recognized as a foreign-based scion of Johnson Controls. The close of the planned merger is expected on or around October 1, 2016.

All in all, I see the merger with Tyco as a smart move by Johnson Controls. The merger will open new markets for the company especially in Europe with complementary products and services. Moreover, significant synergies and tax benefits are expected which could reach $1 billion in three years, according to the companies.

 Johnson Controls and Tyco Merger

Source: The Electrical Products Group Annual Conference

Adient Spin-off

On January 12, Johnson Controls revealed that Adient will be the name of its automotive seating and interiors business after the entity is spun off into a new publicly traded company in October 2016. The distribution of Adient shares is scheduled for October 31. Shareholders will receive one Adient share for every 10 shares of Johnson Controls they own.

Adient will be the world’s largest maker of car seats, as well as other interior parts, last year it posted $20 billion in revenues. The fact that the new company will have its headquarter in London will give it a significant tax benefit. Adient will have a corporate tax rate of 10% to 12% compared to the 17% Johnson Controls paid in the U.S. in the recent quarter.

Johnson Controls’ automotive seating and interiors business continues to perform ahead of expectations. While revenue for the fiscal year 2016 is expected to come in flat year-over-year, margins are likely to exceed targets. The company also said that order wins continued to accelerate during the first half of fiscal 2016 with awards nearly equal to the full year fiscal 2015 levels.

Bruce McDonald, current Johnson Controls vice chairman and future Chairman and Chief Executive Officer of Adient, said in a presentation that he expects Adient to implement new strategies that will drive higher levels of growth and profitability as well as strong cash flows. According to McDonald, Adient will increase its investments in innovation in order to gain share and increase value to customers and shareholders.

I believe that the new company is well positioned to achieve high growth in the following years due to increasing investments, new products, and lower tax rate.

Dividend and Share Repurchase

On May 17, Johnson Controls has authorized a regular quarterly cash dividend of $0.29 per common share. The dividend is payable on July 5, 2016 to shareholders of record at the close of business on June 10, 2016. Johnson Controls has increased its dividend in 36 of the past 38 years and has paid a consecutive dividend since 1887.

The annual dividend yield is at 2.61%, and the dividend coverage ratio TTM is at 59.5%. The annual rate of dividend growth over the past three years was high at 13%, over the past five years was also high at 14.9%, and over the last ten years was at 12.1%.

Johnson Controls Dividend History

Source: company’s reports  *assuming same dividend rate for the year

Johnson Controls confirmed it expects to resume its previously authorized share repurchase program with plans to repurchase $500 million before the end of the fiscal year.


Since the beginning of the year:

However, since the beginning of 2012:

According to TipRanks, the average target price of the top analysts is at $51.33, an upside of 15.5% from its June 10 close price, which appears reasonable, in my opinion.

JCI’s valuation is good, the forward P/E is very low at 10.3, and the price to cash flow is at 19.9. Furthermore, the Enterprise Value/EBITDA ratio is very low at 10.9, and the PEG ratio is also very low at 0.95.

The PEG ratio – price/earnings to growth ratio – is a widely used indicator of a stock’s potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means the stock is more undervalued.  Click here to see the Top 10 PEG ratio Dividend Aristocrats.

Final Thoughts

I see Johnson Controls’ decision to merge with Tyco and to spin-off its automotive seating and interiors business as a smart move by the company. These developments will award the companies new markets, significant synergies and tax benefits.

In my view, JCI’s stock is an excellent candidate for diversified, large-cap dividend stock portfolio. The current dividend yield is at 2.6%, and the company has increased its dividend in 36 of the past 38 years and has paid a consecutive dividend since 1887.

The company ranks as a buy and Top 10 dividend stock using The 8 Rules of Dividend Investing thanks to its low valuation, excellent growth prospects, and above-average dividend yield.

In addition to the dividend payment, investors can also expect capital appreciation, the average target price of the top analysts is at $51.33, an upside of 15.5% from its June 10 close price, which appears reasonable, in my opinion.


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