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Johnson Downgraded to Underperform

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We have downgraded our long-term recommendation on Johnson Controls Inc. (JCI - Free Report) to Underperform. The leading supplier of automotive interiors, batteries and other control equipment is facing challenges from the softness in the global markets along with weak euro, which will affect its profitability. Pricing pressure from OEMs and strong competition also contributed towards the rating downgrade.

The company is facing continued pricing pressure from OEMs due to their high levels of inventory. In addition, volatility in commodity prices of steel, aluminum, copper and fuel in the Building Efficiency business and lead in the Power Solutions business will impair the company’s profitability.

Johnson Controls faces tough competition from major domestic and international manufacturers and distributors of lead-acid batteries in the North American, European and Asian markets. Its main competitors include Magna International Inc. (MGA - Free Report) in the Automotive Experience segment, Honeywell International Inc. (HON - Free Report) in the Building Efficiency segment and Exide Technologies in the Power Solutions segment. In addition, weak demand in the key markets along with a weak euro can also be detrimental to the company’s profitability.

Meanwhile, Johnson Controls is launching new hybrid batteries along with the expansion of its capacity to meet the rising demand. Concurrently, the company is expanding its foothold with the acquisition of the Delphi global battery business. In addition, the company is the leading supplier of start-stop batteries in Europe. Johnson Controls expects the market for start-stop batteries to grow to 35 million units by 2015.

The company expects to benefit from its expansion in China. In the seating business, it commands more than 50% of the country’s market share. Further, the company has invested $500 million in four automotive battery plants in and around Shanghai which will have an annual production capacity of 30 million batteries by 2015.

Johnson Controls, in the third quarter of its fiscal year ending September 30, 2012, registered a 14% increase in adjusted earnings per share to 64 cents from 56 cents in the corresponding quarter a year ago. However, the results missed the Zacks Consensus Estimate by 3 cents. Profit grew 15% to $441 million from $383 million in the comparable quarter of prior year.

Total revenues rose 2% year over year to $10.6 billion in the quarter. However, revenues failed to meet the Zacks Consensus Estimate of $10.9 billion.

Our recommendation on the stock is backed by a Zacks #4 Rank, which translates into a short-term (1 to 3 months) Sell rating.

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