Pivoting To High-Margin Data Center Solutions Fuels Growth And Transformation

Key Takeaways

• Shift towards high-margin engineered solutions and services following divestitures aims to simplify portfolio and improve net margins.
  
• Strategic focus on growing data center solutions and service orders highlights a pivot toward recurring revenue streams, aiming for significant growth and enhanced margins.
  
• Leadership changes, divestitures, and reliance on the data center sector introduce uncertainties and risks impacting revenue growth, investor confidence, and operational efficiency.

Catalysts

Engages in engineering, manufacturing, commissioning, and retrofitting building products and systems in the United States, Europe, the Asia Pacific, and internationally.

• The strong demand for Johnson Controls' data center solutions and the development of a dedicated organization for these services are expected to significantly impact future revenue growth, especially as the company expands its leading position in North America and grows alongside its customers internationally.
  
• The divestitures of the Residential and Light Commercial HVAC and the Air Distribution Technologies business are likely to enhance net margins by focusing on higher-margin engineered solutions and services, simplifying the portfolio, and reducing complexity.
  
• The growth in service orders by 9%, particularly with a 10x potential revenue generation over the lifecycle of the solution, suggests a strategic pivot towards service and maintenance, which offers recurring revenue and could enhance both revenue and net margins through economic cycles.
  
• Investments in technologies and expansion into the fast-growing data center vertical, expected to increase from 7% to 10% of sales, indicate a strategic focus on high-growth areas that are likely to contribute to significant revenue growth.
  
• The ongoing business transformation and operational focus shift towards a more streamlined, service-oriented company are expected to yield more consistent, predictable outcomes, improving operational efficiencies and potentially impacting earnings positively.

Assumptions

• Analysts are assuming Johnson Controls International's revenue will grow by 5.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 6.0% today to 11.7% in 3 years time.
• Analysts expect earnings to reach $3.7 billion (and earnings per share of $5.78) by about August 2027, up from $1.6 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $3.0 billion in earnings, and the most bearish expecting $2.9 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.6x on those 2027 earnings, down from 27.5x today. This future PE is lower than the current PE for the US Building industry at 20.1x.
• Analysts expect the number of shares outstanding to decline by 1.81% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.61%, as per the Simply Wall St company report.

Risks

• The announcement of a CEO succession plan introduces uncertainty regarding future leadership and strategic direction, potentially affecting investor confidence and impacting the overall stability of the company's stock price.
  
• The divestitures of the Residential and Light Commercial HVAC business and the Air Distribution Technologies business, which represent about 20% of current sales, could lead to short-term revenue losses and impact net margins as the company transitions and refocuses its business model.
  
• Reliance on the fast-growing data center segment, while a strategic opportunity, also introduces concentration risk. Any slowdown in this sector could significantly impact revenue growth and earnings.
  
• Operational challenges and execution risk in expanding and managing the significant backlog, especially in the data center vertical, could affect revenue recognition timing and ultimately net margins if not efficiently managed.
  
• Geopolitical and economic uncertainties, particularly the ongoing weakness in China's system business, pose a risk to global operational performance and could negatively impact international sales and earnings growth.

Valuation

• The analysts have a consensus price target of $75.75 for Johnson Controls International based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $93.0, and the most bearish reporting a price target of just $60.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $31.4 billion, earnings will come to $3.7 billion, and it would be trading on a PE ratio of 16.6x, assuming you use a discount rate of 8.6%.
  
• Given the current share price of $66.7, the analyst's price target of $75.75 is 11.9% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.