Tuesday, March 4, 2008

Johnson Controls is an Exception in the Struggling Auto Industry


Think of a company like Johnson Controls (JCI: 33.15, -0.27, -0.80%), which supplies the automobile industry, and you’re likely to think of doom and gloom as the car industry suffers through record declines.

But to the fund managers at Great Companies, Johnson Controls has all the criteria that make it a great company.

“With an automotive supplier, you wouldn’t think great company,’’ said Carl Salvato, a portfolio manager at Tampa, Fla.-based Great Companies, which manages money for institutional investors and private accounts. Johnson Controls has “managed very successfully through the up and down cycles of the last twenty years," he said. "It’s nimble and has maintained reasonable levels of steady earnings growth.”

Johnson Controls, of Milwaukee, Wis., makes interiors and batteries for the automobile industry and provides heating and ventilation systems for commercial buildings. At a time when other auto suppliers have been forced into bankruptcy and have faced worker strife, Johnson Controls has been able to survive, largely because it’s quick to go after growing markets.

Johnson Controls has been “wise to move to Nissan and Toyota ,so when the big three really hit the wall they have not been as badly damaged as the big three,’’ said Salvato, referring to General Motors (GM: 22.84, -0.36, -1.55%), Ford (F: 6.18, -0.01, -0.16%) and Chrysler. “Their overseas presence is beneficial because it takes up some of the slack.”

Salvato noted that Johnson Controls' margins have held up, even as production goes overseas to cheap markets.

“Suppliers have been damaged; they are a survivor. They get more business,” he said, noting that Johnson Controls is supplying the U.S.-based plants for car makers like Nissan.

For its first quarter, which the company reported in the middle of January, Johnson Controls posted a 39% increase in earnings and a 16% increase in sales to $9.5 billion from $8.2 billion in the year-ago first quarter. The company also reiterated its expectations that earnings will increase 18% year over year in 2008.

Great Companies had been a long-time holder of shares of Johnson Controls, but sold off a couple of years back when the markets got wind of the company’s diversification plan and sent the stock flying.

According to Salvato, 35% of Johnson Control’s business comes from the commercial building market, where it supplies and services heating and ventilation systems. Johnson Control’s $3.2 billion acquisition of York International in 2005, gave the company a bigger presence in that market, which pleased investors, thus driving the stock higher. Not to mention the company, according to Salvato, is a leader in the hybrid battery market, with the first generation hybrid battery coming out in 2010. Once the valuation came back down to earth, Great Companies portfolio managers jumped back in.

“I think that over next three years, exclusive of a deep cyclical downturn, earnings can increase 20%,” said Salvato. “In three years the stock could get up to $46 a share.” As of Monday’s stock market close, shares of Johnson Controls was trading at $33.36.

In addition to being a nimble player in a tough market, Salvato said the company pays a “nice” dividend and generated $1.1 billion in cash last year. With substantial cash, Salvato said the company has a lot of flexibility to grow organically and through bolt on acquisitions.

“It’s really a steady eddy cash cow,’’ said Salvato.

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