Johnson Controls Earnings: Specter of Slowing Growth Spooks Market, but Our Outlook Is Unchanged

Johnson Controls JCI shares fell about 10% during Aug. 2 intraday trading after the narrow-moat-rated firm released fiscal third-quarter financial results and revised its fiscal 2023 outlook. We think the market focused on management’s downward revision to organic revenue growth and free cash flow conversion this year. Management now sees high-single-digit organic growth in fiscal 2023 (down from 10% previously) with a 70% free cash flow conversion rate (80%-90% previously).

Organic revenue growth of 9% during the third quarter was strong, but it is decelerating. Second-quarter organic growth was 13%, and management is targeting 4% organic growth for the fourth quarter. As we understand it, tempered demand in Johnson Controls’ shorter-cycle residential HVAC and fire and security businesses is the primary culprit behind management’s guidance revisions. Considering challenging prior-year sales comparisons and our view that the residential HVAC replacement cycle has matured, we’ve been modeling residential HVAC shipments to decline in 2023 (this business accounts for just 5% of consolidated revenue). Management said improving lead times is a key consideration behind fire and security channel destocking; we heard similar commentary from Allegion regarding its commercial security business. Because of greater-than-expected indirect distribution channel destocking, Johnson Controls probably won’t reduce its own inventory as much as management would have liked, which figures into the lower free cash flow conversion target.

We trimmed our revenue growth and free cash flow conversion projections for 2023, but we’re maintaining our $72 fair value estimate as our long-term outlook is unchanged. We continue to believe strong and sustained demand for Johnson Controls’ commercial HVAC products and solutions and a richer mix of service revenue will support above-GDP revenue growth and margin expansion.