Fitch Lowers Johnson Controls' Outlook From BBB+ Stable To Negative

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Fitch Ratings recently downgraded Johnson Controls' ( JCI ) outlook from stable to negative. The downgrade was prompted by a variety of factors, including increasing leverage, a challenging business environment particularly in Europe and in construction markets, and the volatility in the prices of lead - a raw material used in the batteries manufactured by the company. In addition, these factors are exacerbated by the company's low margins in automotive interiors and building efficiency business units.

On the brighter side, the ratings agency has affirmed the company's Issuer Default Ratings (IDR) and long-term ratings at BBB+, and we believe the outlook for the company will be restored to stable as construction markets recover and the global macro-economic environment improves.

We currently have a stock price estimate of $28.68 for the company , approximately 5% above its current market price.

See our complete analysis for Johnson Controls here

Increasing debt, tough business environment and low margins prompt outlook revision

The company has added to its leverage over the past couple of years. The Debt/Equity ratio stood at 0.57x at the end of the quarter ending June 30, 2012, up from 0.53x at the end of 2011 and 0.34x at the end of 2010. The increasing proportion of debt has contributed to higher interest expense as well as the marginal increase in the perceived risk of default.

A challenging business environment, particularly the slowdown in Europe and the slowing growth in emerging economies, has increased the risk associated with default by impacting growth across JCI's business divisions: building efficiency, automotive interiors, and automotive batteries. In addition, the weak construction markets in the U.S. and Europe are continuing to impact sales of the building efficiency division, and the volatility in lead prices is eroding the margins of the automotive batteries division.

The margins of the automotive batteries division are being affected by higher costs of spent battery cores that the company acquires for recycling. Lower volumes of aftermarket battery sales have been driving the prices over the last couple of years, and this has resulted in lower volumes of spent batteries returned, which, in turn, has reduced the overall supply. However, the effect of this factor will be temporary.

The above factors are exacerbated by low margins in the building efficiency and automotive interiors divisions. For example, in the previous quarter, the operating margins in building efficiency and automotive interiors divisions stood at 6.9% and 3.7%, respectively. And the combined sales for these two divisions constituted over 85% of the company's overall sales.

However, long-term growth fundamentals intact

However, Fitch's IDR rating and long-term rating at BBB+ still suggest a low of default based on the long-term growth fundamentals of the company. These include Johnson Controls' market leading position in automotive batteries segment, including the high growth segment of Li-ion batteries for electric vehicles (EVs), and in the building efficiency segment, which drives efficient usage of energy in buildings, and its increasing presence in emerging markets.

We anticipate that the outlook revision could be reversed in the future if the construction markets recover in major markets like the U.S. and China and as the global economic environment improves.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: F , GM , HMC , JCI , UTX

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