Energy Efficiency, Automation, And Service Should Drive Growth At Johnson Controls

One of my preferred names in the hot HVAC space, Johnson Controls (JCI) has done pretty well since my last update, rising about 45% against roughly 30% moves at Carrier (CARR) and Trane (TT) and a weak performance at Lennox (LII) (my other preferred name, Daikin (OTCPK:DKILY) has not done as well). I believe some of this outperformance may be tied to rotation to less richly-valued names, as well as some appreciation for the upside Johnson Controls has in areas like building control, automation, and management, as well as indoor air quality and electrification.

The valuation call today is tougher. I still like the opportunity in those aforementioned market segments, as well as the opportunity to drive better revenue growth and margin leverage from improved service attachment (getting more of the ongoing maintenance revenue from its installed equipment). On the other hand, the shares are pretty richly-valued for what is actually a lackluster margin/ROIC/ROA profile, and discounted cash flow suggests mid-single-digit total annual return potential from here.

 

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Energy Efficiency, Automation, And Service Should Drive Growth At Johnson Controls

Even With Some Well-Known Issues, Johnson Controls Looks Too Cheap

There’s a big difference between investing in a “cheap stock” and “cheap for a reason” stock, and the latter is a sure ticket to years of frustration. In the case of Johnson Controls (JCI), there are certainly legitimate criticisms of the business – the margins are really not that good, the scope of future margin improvement is uncertain, and the business has some definite gaps (particularly in more value-added areas). Even so, factoring in discounts and haircuts for those flaws still leaves me with a valuation comfortably above today’s share price. There is a new risk on the table now with Covid-19 and whether the non-residential market will see a V-shaped, U-shaped, L-shaped, extended L-shaped, or some sort of “jacked up W-shaped” recovery, but long-term trends like building automation and energy efficiency remain as strong as ever. With that, this is a name worth a closer look.

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Even With Some Well-Known Issues, Johnson Controls Looks Too Cheap

Look Past The Current Auto Weakness, And BorgWarner Has Investment Appeal

These aren’t great times for the auto sector, with U.S. auto sales down more than 5% in April, European registrations down 4% in March, and Chinese auto sales down 11% in the first quart of 2019. Against that backdrop, it’s not really surprising that BorgWarner (BWA) is seeing revenue and margin contraction.

Looking out further, though, BorgWarner’s backlog suggests that the company’s leverage to hybrids and EVs is increasing as expected, and while there is still uncertainty as to what the margins on that business will look like, I believe today’s price discounts an excessively pessimistic view. The numbers probably won’t start looking better for BorgWarner until the second half of 2019, and there is still some risk there, but I think longer-term investors may want to dig in and do their due diligence on this underrated powertrain player.

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Look Past The Current Auto Weakness, And BorgWarner Has Investment Appeal

The Tide Is Turning For Ingersoll-Rand

A year and a half ago, I thought that Ingersoll-Rand (NYSE:IR) looked undervalued, and the shares are up more than 70% since then. Now, to be fair, I thought Atlas Copco (OTCPK:ATLKY) was the better pick at that time, and Atlas's almost 80% rise since then isn't that much ahead of Ingersoll-Rand, so I think this had more to do with being generally right that the market was too worried about the long-term future of these industrial businesses.

In any case, Ingersoll-Rand's management has made progress in both improving the business and shifting the sentiment. I frankly think there's been more progress on the former than the latter, and so there could still be some upside as investors take a more "normalized" view of the company and its prospects (rather than always seemingly expecting something to go wrong). The May 10 Investor Day likely isn't going to be revolutionary for sentiment, but a clear discussion of the company's innovation and productivity initiatives as well as its plans for capital deployment could further strengthen that improving trend in sentiment.

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The Tide Is Turning For Ingersoll-Rand

Ameresco Making Headway, But It's Not Easy

Of all the companies to see post-election runs, Ameresco (NYSE:AMRC) is one of the less obvious ones to me. Ameresco's business is built upon helping customers, particularly government and/or government-funded institutions, find ways to boost energy efficiency and lower their electricity bills. What's more, it's a business where the cost of capital for project financing makes a meaningful difference in the cost-benefit evaluation process. Given the incoming administration's priorities, I wouldn't think that investors would be feeling that much more confident now.

In any case, Ameresco does appear as though it might be undervalued, but I have a hard time working up a lot of conviction for it. While it is true that there are myriad ways that companies/offices can reduce energy (many of which aren't obvious and/or require the help of experts) and these ways are generally very cost effective, that has been true for a long time. And yet, a lot of Ameresco's growth has been tied to various government incentive progress designed to goose adoption of these measures. Nevertheless, as a "platform neutral" provider of energy efficiency and cost saving options, I do think Ameresco is at least worth your own due diligence.

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Ameresco Making Headway, But It's Not Easy

Investopedia: Ingersoll-Rand Outperforming As Management Hits Its Marks

Credit were credit is due – Ingersoll-Rand (NYSE:IR) has been in a seemingly never-ending state of restructuring since 2008, but management seems to be hitting its marks recently. Leaner manufacturing, smarter sourcing, a refreshed product line up and solid pricing all seem to be leading to the improved results that have been expected for some time now. Although these shares still don't look particularly cheap, Ingersoll-Rand is heavily leveraged to a recovery in residential housing and commercial construction and continued outperformance on margin targets could very well push the shares higher.

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Investopedia: Johnson Controls Has A Lot Of Improving Left To Do

One of the investment and corporate finance topics that has been getting more airtime recently is the notion of “peak margins” - the idea that many (if not most) companies have squeezed all they can from mass firings, IT investments, and other sorts of cost “rationalizations”. If this theory proves accurate, stocks could well be meaningfully overpriced on the basis of margin expansion expectations that just won't materialize.

That could be a relevant topic in the case of Johnson Controls (NYSE:JCI), as sell-side analysts continue to project margin improvements well ahead of historical experience. Certainly there are reasons to think that this company could be near a point of margin inflection – the building efficiency business should be close to turning and the company may be ready to start reaping better returns from batteries as well. That said, betting on a significant transformation at a company with a record of underwhelming performance could be a risky bet.

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Investopedia: Ingersoll-Rand Improving, But Are Investors Already Too Optimistic?

I will say right from the beginning that I haven't been a fan of Ingersoll-Rand (NYSE:IR) for some time now. While the involvement of activist investors and a commitment to launch debt-funded share buybacks has helped the stock significantly since October of 2011, the next leg of improvement is going to have to come from better execution. This is where I'm not sure the company can deliver, and where I fear investors have given too much of a benefit of the doubt to management. That said, investors who have more faith in management could look to improving construction markets as a driver for the next move in the stock.

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Investopedia: Good Long-Term Trends, But Softer Conditions Today At United Technologies

It's pretty clear that United Technologies (NYSE:UTX) has built itself around two principal themes – the increasing urbanization of the world and the increasing accessibility of commercial air travel in emerging markets. While these look like good horses to ride for the long haul, they don't promise great growth every year. In addition, United Technologies still has to prove that it can successfully integrate Goodrich and make this expensive deal a value-creator for the long term.

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Investopedia: Strong Execution Justifies Honeywell's Price

Many investors are so obsessed with finding bargains that they sometimes overlook excellent companies trading at reasonable valuations. This can be a long-term mistake, as it is often better to own the more expensive stocks of superior companies. That seems like a relevant point with Honeywell (NYSE:HON) today. While these shares are not significantly undervalued today, the quality of the company's execution and the prospects for better margins (and growth) argue for a long-term position.

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Seeking Alpha: Investors Have Bought Ingersoll Rand's Sizzle, Can They Deliver The Steak?

I'll give credit where it's due - the involvement of Nelson Peltz and his Trian Fund Management, and the willingness of Ingersoll Rand's (IR) management to embrace that involvement, has definitely delivered substantial near-term benefits to shareholders. These shares are up more than 40% over the past year as management has committed itself to a greater return of capital, improved operating efficiency, and the spin-off of its security business.

Things may even get better from here. There are actual signs of progress in margins, even though the company remains heavily exposed to end-markets (residential and commercial construction) that are not yet out of their trough. Even so, it looks like investors have already given management ample benefit of the doubt and fiddling with the balance sheet really doesn't seem likely to produce long-term value.

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Investors Have Bought Ingersoll Rand's Sizzle, Can They Deliver The Steak?

Investopedia: Honeywell Comes Through, But Valuation Isn't So Sweet

What a difference a month or so makes. With investors happy to see Congress play kick the can with the fiscal cliff, industrial stocks have caught a second wind and done quite well over the last month. While Honeywell (NYSE:HON) is a quality industrial conglomerate that often seems to get overlooked, management's modest guidance for 2013 and the company's mediocre free cash flow history don't really argue for aggressively chasing these shares at this point.

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Seeking Alpha: Faith In Johnson Controls May Be Running Ahead Of Facts

While I understand that Wall Street is a discounting mechanism that looks forward more often than backward, I have a hard time reconciling the confidence that investors have shown in Johnson Controls (JCI) over the past three months with the likely trajectory of performance.

Johnson Controls said many of the right things at its recent analyst day, addressing issues like margin challenges in the automotive and building systems businesses and pointing to a promising future in batteries, but it seems like analysts are much too willing to reward the company with unprecedented operating improvements. A slight beat for the fiscal first quarter is certainly better than another miss, but back-loaded guidance and iffy auto margins leave me hanging on to some skepticism.

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Faith In Johnson Controls May Be Running Ahead Of Facts

Investopedia: A123's Story Ends With A Zero

With the bankruptcy auction of defunct battery developer A123's (OTC:AONEQ) commercial assets now complete, the story is over and common shareholders will walk away with a total loss. Not only does the A123 story serve as a bitter reminder of the sizable hurdles that new energy-tech companies must face, but also the dangers of buying into the hype at the cost of scientific and economic realities.

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Investopedia: 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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Seeking Alpha: Ingersoll-Rand And The Power Of Change

When I last wrote on Ingersoll-Rand (IR) in February, I thought that this industrial conglomerate was the sort of perennial underachiever that could do well if and when management started delivering better results and the market really bought into the idea of reliable improvement. Although it's still early, it looks like Nelson Peltz's involvement with the company has improved sentiment, and it does look like management has credible plans for healing what has been a long record of underperformance.

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Ingersoll-Rand And The Power Of Change

Seeking Alpha: Emerson Doing It The Hard Way

This has been a decidedly mixed quarter for industrial companies, made perhaps slightly more tolerable by consistent management guidance earlier this year that it would be a challenging quarter. That said, Emerson (EMR) has been on a concerning streak of late with uninspiring quarterly performance (relative to expectations) and low order growth. Although management has remained rather consistent in tone and substance, Emerson's shortfalls are increasing turning it into a "show me" story with investors.

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Emerson: Doing It The Hard Way

Seeking Alpha: UTX Looks Like A Bargain, But Share Loss Is A Worry

One of the reasons that conglomerates often used to carry discounts to pure-plays was the fear/belief that management teams struggled to keep a careful over all of the moving parts of the businesses in the stable. In the case of United Technologies (UTX) I can see the point. While UTC looks to be in excellent shape to benefit from the ongoing commercial aviation upswing, I do worry a bit about businesses like Otis and Climate Control.

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UTX Looks Like A Bargain, But Share Loss Is A Worry

Investopedia: EnerNOC Still A When AND If Story

It all sounds so simply, really. Improving energy efficiency frees utilities from building expensive new plants, lowers power bills and improves generating efficiency. So EnerNOC's (Nasdaq:ENOC) demand response model should be in real demand. Unfortunately, it hasn't been anything nearly so simple, and EnerNOC investors are still wondering if this company's business plan can gain real traction.

Customer Diversification Will Be a Challenge
One of the big issues for EnerNOC thus far has been its customer concentration. PJM Interconnection is responsible for over half of the company's revenue, while ISO New England comes in at another 20%. Given the recent issues with the FERC ruling on PJM's demand response policies (more on this later), this has become a bigger issue.

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Investopedia: Maxwell Offers Energy Tech With A Real Model

Energy tech is a perennially exciting market, even as the attention shifts from year to year among fuel cells, solar panels, wind power, batteries and so on. What makes Maxwell Technologies (Nasdaq:MXWL) unusual, though, is that it's a company with real revenue, real products and actually just a bit of profitability. While there is still very much a "build it and they will come" aspect to the company's targeted markets, Maxwell looks like a better play on the future of power alternatives.

Rare Profitability
A lot of energy tech has been divvied up between unprofitable speculative companies with little more than patents and prototypes and giant industrial/technology concerns. That makes Maxwell's profitability rather uncommon.

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