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Morningstar | Johnson Controls Reports Strong 2Q Results and Completes Power Solutions Sale

Shares of narrow-moat-rated Johnson Controls traded higher on May 1 after the company reported strong fiscal second-quarter results that topped consensus earnings expectations, completed the sale of its power solutions division, and raised its full-year EPS guidance. While Johnson Controls got off to a shaky start after spinning off its automotive seating business (Adient) and merging with Tyco (both in calendar 2016), its financial performance and management’s credibility with investors have greatly improved under CEO George Oliver’s watch. We expect Johnson Controls’ fundamentals will continue to improve over the coming years as the firm realizes returns from recent reinvestments and continues to extract synergies from the Tyco merger. Our long-term outlook for Johnson Controls has not changed, and we’re maintaining our $46 per share fair value estimate.

Second-quarter sales grew 3% (6% organic) year over year to $5.8 billion, in line with consensus expectations, but the 23% increase in adjusted EPS to $0.32 beat the consensus estimate by $0.02. Johnson Controls’ robust earnings growth was primarily driven by a more than 10% increase in adjusted operating income (adjusted operating margin expanded 60 basis points to 10.4%) and lower interest expense and diluted share count.

Johnson Controls announced that the sale of its power solutions business was completed on April 30 for net proceeds of $11.6 billion. The sale was finalized two months earlier and netted $200 million more than management had expected. Management still intends to use $3.4 billion of the proceeds to pay down debt, with the remainder allocated to share repurchases. The timing of the sale allows management to reduce debt and share count earlier than previously projected. As such, management now expects full-year 2019 EPS of $1.85 to $1.95 (versus $1.75 to $1.85 previously) due to lower interest expense and share count assumptions in fiscal 2019.

While organic order growth decelerated sequentially to 2% versus 7% last quarter, management attributed the lower pace to timing, but pointed to a strong pipeline of projects as support for its guidance of mid- to high-single-digit order growth during the second half of fiscal 2019. Johnson Controls’ backlog is up 6% year over year to $8.8 billion, which provides financial performance visibility over the next two years. Oliver said during the earnings call that “end markets remain healthy, with no notable slowdown in any of [the firm’s] internal leading indicators."

Synergy realization continues to have a demonstrable impact on Johnson Controls’ bottom line. The $0.06 year-over-year increase in adjusted EPS was driven by $0.06 of favorable volume and mix, $0.04 from synergies and productivity initiatives, offset by $0.02 reinvestment in the firm’s salesforce and other projects and $0.02 related to other minor net expenses.