“…Tear open a car — not something I recommend — and you will find Johnson Controls all over the place. Seating, door panels, consoles, car battery, you know, Interstate…they’re going to send Johnson Controls soaring through the $30’s now that we’re building cars again. JCI could be the biggest winner, not loser, in your portfolio.” — CNBC’s Mad Money 1/11/2010
CNBC’s Jim Cramer has been all over Ford Motor (F), specifically the preferred shares, as a way to play a rebound in the auto industry. Market share gains and strong leadership from CEO Alan Mullaly have the stock trading more than 350% higher than a year ago, so that ship has sailed in the eyes of many value oriented investors. That being said, Cramer maintains that the auto sector remains in the midst of a recovery following dreadful cars sales data in the second half of 2008 and first half of 2009. So, Cramer is on the hunt for other stocks that will take advantage of the sort of recovery Cramer believes is in store for autos.
Cramer’s stock of choice is “best of breed” auto supplier Johnson Controls (JCI). Johnson Controls makes car interiors, batteries, and various other components that each new car needs. The company stands to see sales gains if you believe auto dealers will be restocking depleted inventory and consumers will begin to buy cars with a more historically normal frequency. However, the company is certainly not a pure play on the auto sector. JCI gets just about half of their sales and less than half of profits from the auto supplier division, as the company also has a large and fast growing presence in the HVAC business.
For Johnson Controls, sales in fiscal 2009 decreased 25%, and the auto division was the biggest lag with revenue dropping 34%. Clearly, the auto supply business was the most glaring weakness for a company that is normally very consistently profitable. For example, looking back five years there have only been two quarterly losses for JCI and they were in the quarters ended 12/31/08 and 3/31/09. Apart from those two quarters, the company has met or exceeded analysts’ projections every other quarter in those five years. The improvement in the auto sector has already allowed the company to return to profitability, and that has clearly not been lost on Mr. Market.
At Ockham, we disagree with Cramer’s assessment of Johnson Controls. Although we believed the stock was a great buy in March and April, the stock has appreciated quite a bit from then and now receives our Overvalued rating. At this point, the stock has begun to see earnings recover, and management’s consistent track record is noteworthy. However, according to our methodology the price has appreciated too quickly and future earnings may not be enough to justify the price level. Cramer would advise buying under $30 per share, but we cannot share in his enthusiasm for this stock or his belief in a continued robust auto sector recovery. He views the auto sector as a new “hot sector”, but if history has told us anything, it is that the auto industry is extremely challenging. It seems some investors want to believe that the industry is “fixed” which may help stocks in the short term, but we need to see continued earnings improvement before we can believe.
