The shares of Johnson Controls International PLC (JCI) are down about 11% over the past twelve months, and the current price represents an excellent entry point for prospective shareholders. The merger with Tyco International created a global leader in building and energy storage solutions. Although the market has seemingly not approved of the merger, the combination is a good one that will deliver decent returns to shareholders over the next few years in my estimation. Ill go through my reasoning below by modelling what I think is a reasonable future price based on dividend growth for the merged company, and by making an appeal to authority. Ill conclude with a discussion of the relative merits of this stock versus the overall market.
Financial History
Obviously in a situation like this, the financial history of the pre-merged company is less relevant than that of a company that has not undergone such a significant financial engineering event. That said, I think its worth highlighting a few key facts about the capital structure. I want to look at the balance sheet, as its usually the source of risk post merger.
The debt load has obviously grown, but the vast majority of it (67.5%) is due after 2021. This suggests that theres little risk of a credit or a solvency crisis anytime soon. Additionally, the current interest rate of 3.9% is sustainable, suggesting that the debt used for the merger is not excessively priced. For these reasons, Im less concerned about the financial impact of the merger than I otherwise might be.
Modelling the Dividend
In the absence of a long history, the ability to forecast is particularly important. Whenever I forecast, I engage in a ceteris paribus assumption, meaning that I hold all constant but one variable. I consider the dividend to be the most significant driver of value here, so Ill model it while holding everything else constant.
Over the past six years, the dividend per share has grown at a CAGR of just over 6%. I consider this to be a reasonable expectation of the future growth in the dividend per share, so Ill model this growth rate. When I do so, I infer a CAGR for the shares of about 8.5%. I consider this to be a very reasonable rate of return, given the risk present. Additionally, most of this return is from dividends, which are obviously a more reliable source of investor returns than stock price.
Appeal To Authority
As confident as I am in my forecast, I must acknowledge that there are some investors who are more well informed than I am. When given the opportunity, it would be wise to follow in the footsteps of these investors. With that in mind, Id like to point out that last month, two insiders (George Oliver and William Jackson) have put just over $1.7 million of their own capital into the company. In my view, it makes sense to ride on the coattails of people who are, by definition, more well informed than the rest of us. If they are willing to put their personal capital to work, the risk of me following along is much reduced in my estimation.
Technical Snapshot
As per our ChartMasterPro Daily Trade Model, the trend for JCI would turn bullish with a daily close above $38.00. This would signal a bullish breakout from an Ascending Triangle on the daily charts. From here, we see the shares climbing to the $42.00 level over the next three months.
We will buy JCI call options that will provide us with approximately 13x leverage on our long trade. Our initial stop-loss exit signal will be a daily close below $37.00.
For investors in the shares, we recommend that you hold for three months or $42.00, whichever comes first. For longer-term investors (years, not months), we believe JCI is a solid addition to any dividend growth portfolio over the next four years.
Conclusion
Investing is a relativistic game, meaning that we must buy X and sell Y. In my view, it makes the most sense to buy the cheapest X while actively avoiding expensive Y. At the moment, the newly merged company represents the best risk reward relationship. The shares of Johnson Controls are trading at a 15% discount to the overall market. In the relative game of investing, this is a significant perfect storm in my view. The company has the potential to continue to grow shareholder wealth at a decent rate, while the shares trade at a significant discount to the overall market. In my view, wed be wise to buy at these levels before price and value inevitably collide.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in JCI over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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