What Is Johnson Controls Telling Investors About Auto Parts?

What Is Johnson Controls Telling Investors About Auto Parts?

There is an occurrence in poker called a "tell", or a change in a player's demeanor that gives a clue to whether that player has a good or bad hand. In a recent analyst meeting, Johnson Controls , a diversified industrial manufacturer with over $40 billion in annual sales, emphasized a desire to reduce their exposure in the auto parts sector. Could that be a "tell" indicating the best might be past for auto parts suppliers? Let's take a look at Johnson Controls and competitors Lear Corp. and Visteon Corp. and see.

Johnson Controls: moving away from auto parts
While Johnson Controls also produces temperature control and ventilation systems for buildings, most of its revenues are automobile related. The company manufactures car interiors, seating and batteries. Its recently announced plan to reduce reliance on the auto parts sector could be a meaningful sign. The company earlier said that it was looking at divesting its automotive interiors operations after having already sold part of the vehicle electronics business.

Why would Johnson Controls want to lessen exposure to the automotive sector when, by all accounts, car sales are the highest they've been in years? It appears the parts business may not be able to provide acceptable growth. While the company expects global automotive production to increase noticeably across all key geographic regions in 2014, it sees flat or declining sales in its automotive interiors business. In automotive seating, an industry leading division, it anticipates sales to only increase 1% to 2% outside the fast growing Chinese market. These expectations being appreciably lower than recent 2013 company results.

Johnson's automotive experience business segment, basically car seating, interiors and electronics operations, saw revenues increase 9% year over year in the latest quarter. Demand in China, which is primarily related to seating and met through minority-owned joint ventures, increased 20%. So why the apparent slowdown in 2014 when current business looks so good? A competitor might help to explain.

Lear: great results but a hint of trouble
Lear, another leading global auto parts supplier, also reported excellent recent quarterly results. Company sales were up 11% from 2012 and operating earnings rose 15%. The performance was boosted by increased global vehicle production, which grew 8% in China, 6% in North America and 2% in Europe and Africa.

Looking beyond the headlines, there were some troubling signs, however. Though sales were up 9% in the company's seating business, earnings decreased due to a change in key product manufacturing layouts and selling price reductions. In Lear's electrical systems division, which saw sales grow 17% and earnings increase from 2012, gains were also partially offset by pricing declines.

It's unusual to see product price drops in a robust demand environment. Is Johnson Controls' lukewarm view of the industry related to these pricing pressures? It's likely. Selling price deterioration could be a sign of a much tougher auto parts operating environment to come. Vehicle manufacturers typically require auto parts suppliers to reduce prices over the life of a vehicle model. At the same time, suppliers must assume design, development and engineering costs for new model product. The combination of lower prices and higher capital costs puts significant stress on the parts makers. In an industry that does not typically generate a lot of free cash flow, there can be substantial risk if the new vehicle models do not sell adequately.

Visteon: reducing exposure while maintaining financial control
Visteon, another leading global automotive supplier, looks like it confirms industry caution. The company operates through a family of subsidiary companies. While it owns a majority stake in some, they may have a minor share in others. This type of corporate setup seems logical as Visteon does most of its business overseas and many of the subsidiaries are based in other countries. Through subsidiary ownership, the company has established local partners in far-away lands but may also have less direct operational influence.

Business appears to be doing well though. Visteon's sales were up nearly 7% year over year and net income jumped to $43 million from $28 million in the latest quarter, but pressures were felt still. In the company's climate controls division, its largest providing around 65% of all revenues, sales grew over 10% but pricing strains hindered further gains. Car interiors sales decreased over 4% thanks to lower European demand and price impairments.

Even with excellent performance, Visteon does not appear to be considering expansion. The company seems more comfortable with share buybacks and reducing its manufacturing footprint. A $125 million accelerated stock repurchase program was launched in the latest quarter, part of a $1 billion total initiative. The company also announced the sale of a Chinese partnership. While acquiring a majority equity stake in the venture, Visteon looks to be selling off ownership of the assets. The transaction, expected to provide proceeds of over $1 billion, presumably helps fund the buyback of shares.

Johnson Controls' trimming of exposure to the automotive sector may be telling. In what seems to be great times for vehicle sales, muted optimism and a general lack of expansion plans may indicate difficult times could be ahead for the parts makers. Recent events such as Ford Motor's announcement of projected first-quarter 2014 production being 770,000 vehicles, down from 784,000 a year earlier, can only make auto suppliers even more cautious. Given these auto parts industry "tells", and an incredible stock price run in 2013, investors may find it prudent to be equally wary of the sector.

There's a huge difference between a good stock, and a stock that can make you rich
The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

The article What Is Johnson Controls Telling Investors About Auto Parts? originally appeared on Fool.com.

Bob Chandler has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Originally published