Johnson Controls Upped to Neutral

We have upgraded the long-term (more than six months) recommendation on the shares of Johnson Controls Inc. ( JCI - Analyst Report ) to Neutral from Underperform due to its growing battery business, strong acquisition policy and long-term focus on emerging markets.

The company’s battery business is set to grow globally from new hybrid wins, and the company is adding capacity to meet demand. Last year, the company invested $138.5 million to convert its battery plant near Toledo, Ohio into an Absorbent Glass Mat (AGM) battery facility, the first in the U.S., to manufacture Start-Stop and other batteries for high efficiency vehicles.

Currently, Johnson Controls is the leading supplier of Start-Stop batteries in Europe through its VARTA brand. It believes the market for Start-Stop batteries will grow to 35 million units by 2015, with the U.S. being the principal market.

Johnson Controls also expects to grow through meaningful acquisitions and joint ventures as well as from its focus on the emerging markets, including China and India. Recently, the company announced that it will acquire a 49% stake in Karat Guc Sistemleri Sanayi & Ticaret AS, a Turkey-based distributor of car-batteries.

It also formed a 50:50 joint venture with India-based automotive instrument cluster supplier Pricol Limited that will develop and manufacture instrument clusters, displays and body electronics for both car and motorcycle industry in India. The joint venture will help Johnson enter a new market segment by gaining access to Pricol’s instrument cluster offerings and customer base for motorcycle manufacturers.

In China, the company has acquired more than 50% of the country’s market share in the seating business. It has started to invest $500 million in four automotive battery plants in and around Shanghai to meet excess demand in the country. The plants will have an annual production capacity of 30 million batteries by 2015.

However, original equipment manufacturers are continuously forcing suppliers such as Johnson Controls to reduce prices due to their high inventory levels. Further, the company faces strong competition from major domestic and international manufacturers and distributors of batteries.

We are also disappointed about the company’s grim outlook. The company lowered its earnings guidance for the second quarter and the fiscal year 2012 due to decline in automotive production in Europe, weak demand for aftermarket battery due to weather-related factors and lower demand for residential Heating, Ventilating and Air Conditioning (HVAC) systems.

Johnson Controls is a supplier of automotive interiors, batteries, and other control equipment. The company functions through three segments: Automotive Experience, Building Efficiency and Power Solutions. Its main competitors include Tenneco Inc. ( TEN - Analyst Report ) .

In the first quarter of its fiscal 2012, the company posted a 9% increase in profit to $410 million or 60 cents per share from $375 million or 55 cents per share in the same quarter of the prior fiscal year. However, the profits were lower than the Zacks Consensus Estimate by 2 cents per share.

The higher profits were attributable to higher earnings in the company’s Power Solutions and Automotive Experience segments. Net sales in the quarter rose 9% to $10.4 billion, which is slightly lower than the Zacks Consensus Estimate of $10.5 billion.