On a day like yesterday, when the Dow Jones Industrial Average lost 175.99 (1.07%), the S&P 500 16.4 (0.89%) and the Nasdaq 0.57%, I find myself naturally casting around for value. That general decline, when it comes during earnings season, will quite often see the kind of situation we had yesterday, where a company reports earnings and an outlook that are around what was expected, but gets hammered in the prevalent atmosphere of negativity. It is not necessarily that the general decline is over, but as it happens, such stocks will approach a level where the opportunity looks too good to miss.
Johnson Controls (JCI) has been a stock that I have liked for a while now. I first recommended JCI in these pages back in July and it climbed steadily from then, reaching a high of $52.50, or +28.29% since that article, a couple of weeks ago. It stalled and was hovering as earnings approached, then, after the release yesterday, JCI dropped around 4%. So, you think, they must have missed badly, right? Well, not exactly.
In their report before the market opened yesterday, JCI announced earnings that had increased 33% Year on Year (YoY) and were in line with estimates, a slight beat in revenues and a guidance within the expected range. Not stunning, but not bad either, yet still the 4% hit... oh, the joys of earnings season!
Concerns about China have been cited and that market is important to JCI, whose core business is automotive supply. Yesterday's flash Markit/HSBC PMI fell to below 50, indicating a contraction in Chinese manufacturing. Of course that matters, as JCI's sales there increased 33% YoY and revenue from China of $1.9 Billion out of a $5.8 Billion is not insignificant. I just can't escape the feeling that a slowdown in growth in China is hardly a surprise, though, and I am reluctant to put too much stock in a number released immediately before the Lunar New Year celebrations begin.
Often, when a market drops, the old "The bigger they come, the harder they fall" adage comes into play. As I pointed out, JCI had a good second half of 2013 and estimates have now caught up with performance, so some degree of correction was to be expected. The fact that this came on a down day with some negative news out of China just magnified the drop.
Let us consider the fundamentals for a moment. As I pointed out back in July, JCI is shedding underperforming parts of their business and returning to a concentration on their core businesses. That process continues with an agreement to sell the last of their electronics business being finalized in the last quarter. They have seen growth in revenues and margins and expect to continue to do so. They announced an increased dividend and will continue with share buybacks. They are trading at a very reasonable forward P/E around 16. When you look at it like that, it is pretty hard to make a negative case.
The thing about JCI is that, while they derive business from supplying the traditional automotive market, particularly car interiors, they are also well placed to benefit from the demand for energy efficiency. Their Global Workplace Management and Building Efficiency divisions focus on just that, while their battery division is a leading supplier of advanced batteries used in hybrid and electric cars as well as traditional, lead-acid batteries. Even if the rate of Chinese growth slows, those areas are likely to maintain a positive impact.
The market, as I have said many times including just a couple of days ago, can never be wrong. By definition, the last price traded is the correct one as it is where both a buyer and a seller were prepared to do business. That said, however, traders can get carried away with a theme at times and overshoot a move. That is what I believe happened yesterday with JCI. That doesn't mean that it won't continue today as the broader market continues to fall. The S&P 500 is indicating a lower opening and so is JCI, with trading below $49 as I write, but the more exaggerated the drop, the faster the bounce back will be.
It seems, then, that JCI has been caught in a perfect storm. A market correction and evidence of slowing growth in China came just as the company announced solid, rather than spectacular Q1 2014 results. This may be bad news if you came late to the party and bought above $50, but, assuming that the broader market bounces back, this drop to around $48 could well turn out to be good news for anybody looking for a bargain.