Fitch Ratings recently downgraded Johnson Controls' (
) 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
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
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
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