Johnson Controls

Johnson Controls reported 9% sales growth to $6.6 billion and EPS growth of 15% to $1.23 per share. More impressively, orders grew 27%, and the backlog grew 32% to $21 billion, which bodes well for future growth.

Why it matters: The company is experiencing broad-based growth across most of its portfolio, led primarily by its HVAC solutions. More specifically, the company indicated that data centers will likely account for a high-teens percentage of sales in fiscal 2026. The core Americas region is driving the bulk of the growth, with 37% order growth and 260 basis points of margin expansion to 21.1%. The company is experiencing above-average operating leverage (nearly 50%). APAC delivered 12% order growth and EMEA 6% as the Middle East conflict weighs on demand. The company boosted its 2026 sales growth guidance to 8%, versus 6%, and EPS of $5.05 from $4.85 (up 4%). More importantly, the company affirmed a long-term growth algorithm of high-single-digit organic growth, 30%-plus operating leverage, and double-digit EPS growth.

Long view: On the call, management expounded on its data center solutions, and it was very impressive. The company is likely a market share leader and seems to have a very powerful value proposition. When considering the attached service opportunity, there is a very long runway for future growth.

The bottom line: We are increasing our fair value estimate for narrow-moat Johnson Controls to $129 per share from $111 on the boost to current guidance, the more confident long-term outlook, and the time value of money. Management also commented that the fire and security businesses are performing well, though realistic growth expectations there are for low-mid single digit growth.

Our $129 fair value estimate equates to about 25 times our 2026 earnings per share estimate of approximately $5.12, which is reasonable in historical context. Management is guiding to accelerating growth in fiscal 2026 on improving backlogs, especially in data centers, a dynamic being observed across the peer group. Having reshaped the portfolio to focus on global HVAC and building automation, management is now targeting accelerating top-line growth in the midsingle digits and margin expansion driven by low-single-digit underlying market growth, improving product mix, and increased aftermarket/services penetration. We believe that HVAC is growing faster than building automation, resulting in a growth profile somewhat lower than peers.

We model approximately a 8% revenue compound annual growth rate with approximately 50 basis points per year of margin improvement to 22%, which foots with peer group commentary and management’s own guidance of 50% incremental margins on sales. Given the various corporate actions taken to focus the business, now is the time for management to execute, especially with regard to aftermarket attach rates and margin expansion. Given the CEO’s record of success elsewhere and evidence of similar performance across the peer group, we find these estimates to be credible.

With modest capital expenditures at 2% of sales and research and development likely comparable, we anticipate Johnson Controls to generate healthy free cash flow, which should expand its optionality.

Our stage two forecast period incorporates an estimated investment rate of 25% and earnings before interest growth rate of 6.5% with perpetual growth of 3%. An 8.6% weighted average cost of capital derives from a market-average cost of equity and the firm’s current capital structure.

We assign Johnson Controls a Narrow Morningstar Economic Moat Rating, supported by intangible assets and customer switching costs across its commercial HVAC and fire/security activities, which represent 60% and 40% of sales, respectively. There are relatively few companies in the commercial buildings HVAC space, and the market for large, complex HVAC systems (known as applied HVAC systems) is the most consolidated, especially in the United States. Four players—Trane, Johnson Controls, Carrier, and Daikin—essentially control the US applied HVAC market. Commercial HVAC competition on a global scale is more competitive, especially in Asian markets, where Daikin, Midea, and Gree are meaningful competitors. However, those firms focus more on ductless residential systems.

Johnson Controls’ technological know-how and service capabilities are key differentiators in commercial HVAC, especially for large, complex projects in which engineers tend to provide the sales/service as opposed to contractors who install residential solutions. Over the years, these differentiators have allowed the firm to build a large installed base, which can have long useful lives (up to 40 years for applied HVAC systems). An installed base of commercial HVAC systems is an important asset that can generate recurring revenue over the lifetime of the installed system and is priced at several multiples of the initial product sale. Given the mission-critical nature of commercial building systems, maintenance, service, and aftermarket parts are needed to avoid disruptive and costly system breakdowns.

We believe Johnson Controls’ Metasys and OpenBlue building automation platforms set the company apart from its closest HVAC peers Carrier (Lynx) and Trane (Tracer). These platforms generate recurring software upgrades and subscription-based revenue. Perhaps more importantly, Johnson Controls’ building automation solutions can strengthen its value proposition to customers. Though revenue and market share aren’t disclosed, it would appear Johnson Controls at least enjoys a first winner advantage with this solution, and it likely enhances customer stickiness.

New commercial HVAC systems require significant upfront investment and installation time but have long lifecycles. As such, we believe building operators would be reluctant to completely replace entire systems and instead prefer to retrofit existing systems to adapt to changing technology, regulatory standards, and user requirements. This is a favorable dynamic for Johnson Controls, which is well positioned to capture incremental retrofit revenue in addition to unplanned service and routine maintenance revenue.

That said, the ability to capture future service revenue from an installed base is not guaranteed, especially for less sophisticated systems. We believe third-party service companies can generally service many commercial HVAC products, and some customers have internal engineers who can service systems to a certain extent. However, third-party or internal service engineers would still need to purchase aftermarket parts from the incumbent manufacturer for many projects.

With the Tyco merger in 2016, Johnson Controls added a large installed base of fire suppression and detection, access control, and electronic surveillance systems. Before the merger, Tyco’s approximate revenue mix was 20% products, 40% installation, and 40% service (monitoring, preventative maintenance, repair, and upgrades). Tyco management estimated that roughly 65% of service revenue was recurring (or 25% of total revenue). The global fire and security market is very fragmented. We believe Johnson Controls is the market leader with low-double-digit to midteens market share. Honeywell is its closest and largest fire and security rival. In our view, Johnson Controls’ portfolio of well-known fire and security brands, product breadth, system design, installation, and service capabilities and global scale are key differentiators that have helped build lasting relationships with key decision-makers, such as engineering and construction firms and building owners. Furthermore, we think Johnson Controls’ fire and security installed base is quite sticky, with the firm likely to secure contracts for system upgrades and expansion.

Few of Johnson Controls' competitors offer such a comprehensive suite of commercial building systems and related services. As such, there are few alternatives for building operators that value Johnson Controls' one-stop-shop approach and prefer to use one firm's equipment and services for its key building systems.

Johnson Controls operates an extensive branch network to provide installation and services for its customers around the globe. While myriad HVAC and fire and security service providers exist, few have the revenue base to support a similar-size branch network. As such, Johnson Controls is much better positioned to directly service customers that have multiple locations across the US and the world compared with local and regional competitors that don't have the scale to profitably service customers with national or multinational footprints. Furthermore, we believe Johnson Controls' branch density results in better service quality.

Johnson Controls could achieve more-dominant share, especially in commercial solutions, widening its gap with Trane and Carrier.

Services/aftermarket attach rates could grow above management’s double-digit target and further enhance returns.

Having reshaped the portfolio, management may demonstrate greater capital allocation discipline.

Pricing power could erode due to insufficient product differentiation.

Independent third parties might capture more of the aftermarket/service opportunity.

Returns could deteriorate from lack of focus at fire and security, or Johnson exits that business, reducing scale advantages.