DBRS Confirms Johnson Controls at A (low)

DBRS has confirmed the Senior Notes rating for Johnson Controls, Inc. (JCI or the Company) at A (low), with a Stable trend. The Company’s financial risk profile has stabilized, with improved earnings and cash flow over the past year. JCI’s business risk profile remains in line with the current rating, and the near-term outlook for the Company is favourable. DBRS expects modest improvement in JCI’s financial performance from its increasingly diversified revenue base over the near term, as well as from further debt repayment.

JCI’s high degree of sales diversification is largely responsible for its favourable business risk profile relative to the North American auto parts industry average. Strength from its Building Efficiency division (e.g. climate control and energy management systems and services, largely from commercial customers) and Power Systems business (automotive batteries, mainly sold to the automotive aftermarket), more than offset declining Automotive Experience (interiors) earnings over the past year. The Company’s Building Efficiency earnings, which benefited from the integration of York International Inc. (acquired in 2006), are driven largely by technical services and replacement, which are less cyclical and account for the largest share of JCI’s operating income. Importantly, the Building Efficiency and Power Systems divisions together currently account for close to 50% of total sales versus roughly 30% in fiscal 2004. As such, JCI’s enhanced sales diversification is expected to add stability to earnings. Over the near term, growth in earnings and cash flow is expected to be driven largely by favourable demand for building efficiency systems/related support services (notably commercial), automotive batteries (mainly aftermarket versus original equipment manufacturers (OEMs), and efficiency gains.

Despite the favourable outlook, margins are likely to be constrained by weak U.S. automotive parts industry conditions, which have been well documented. JCI’s exposure to the industry is reflected in its business risk profile, which limits near-term upside to the rating. While JCI’s exposure to the U.S. Big Three (General Motors Corporation, Ford Motor Company, and Chrysler) has moderated, it remains relatively large at close to one-third of sales. U.S. Big Three market share is expected to remain under pressure, and the risk of a strike (which is much diminished, but remains a possibility) also provides downside risk to earnings.

JCI is expected to continue the trend of generating favourable free cash flow, which provides financial flexibility. The Company reduced debt in fiscal 2007 mainly from free cash flow, and the trend is expected to continue. JCI is targeting a debt-to-capital ratio of 30%, and coverage ratios are also expected to improve. The Company remains acquisitive, but large debt-financed acquisitions that would significantly impact JCI’s balance sheet are viewed as unlikely.

Notes:
All figures are in U.S. dollars unless otherwise noted.
This rating is based on public information.