Johnson Controls-Hitachi Air Conditioning

Stock Opportunities Untested - but worth a good look
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This is my first attempt in writing to analyze the stock. Please feel free to provide your inputs.

Johnson Controls- Hitachi
Incepted as a joint-venture between two companies, the US-based Johnson Controls and Japan-based Hitachi Appliances, Johnson Controls-Hitachi Air Conditioning India Limited (JCH-IN) is one of the top three players in the Indian air conditioning market today. Established in 1984, the Company has grown from strength to strength over time and today JCH-IN is one of the most respected and largest business entities in the air conditioning products industry in India.
Headquartered in Ahmedabad, Gujarat, the Company has its state-of-the-art manufacturing facility located at Kadi, Mehsana. The Company’s manufacturing facility not only boasts of manufacturing a wide range of cooling products from residential to commercial cooling solutions but is also one of the largest single roof manufacturing facilities in India.
Complimented by a wide array of cooling products, the Company aims to become the number one HVAC Company in India by 2021 along with the enhancement of its market share in both B2c and B2B.

Product Offering
Offerings include home, industrial, and commercial cooling solutions like commercial air conditioning, residential and conditioning systems, absorption and centrifugal chiller systems, and heating & cooling (HVAC) systems among others.

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• Room Air Conditioners: The Company is one of the top brands in India with a market share of approx. 12% in the Air Conditioner segment and is further anticipated to increase significantly by 2020-21

• Variable Refrigerant Flow (VRF): The Company’s VRF segment registered a growth of 14% in the previous financial year while, during this period, the growth rate was 25%

• Application-Based Air Conditioners – Telecom Air Conditioners: The company continues to dominate this segment being the single largest air conditioning solution provider for the cooling requirements in Telecom Towers. However, stiff competition and stressed margins in the telecom industry has led to lower or marginal investments in Capex based infrastructure

• Exports: Since the last few years, the Company has expanded its geographical boundaries in the export business. In the last couple of years, the Company has started exporting to Sri Lanka, Indonesia, Bangladesh, UAE, and Nepal, and this year added Bhutan, Myanmar, Maldives, Oman, Bahrein, Qatar, Saudi Arabia, Iraq and few countries like Kenya and Djibouti in Africa Continent. With aggressive focus and improved product lineup for exports, the Company has registered significant growth over last year

• Home Appliances: In the Home appliance segment, the Company deals in the premium range of refrigerator and air purifiers. The domestic refrigerator industry is witnessing a major transformation right from product and design innovations to giving value for money and energy-efficient solutions to consumers with a variety of choices. Gradually the consumer preference is moving towards high capacity models. These high capacity models offer the latest technologies like inverter technology with dual fan cooling, vacuum insulation panels, intelligent controls, etc. The Indian residential air purifiers market is anticipated to grow at a CAGR of over 29% from the current level of 14.14 million dollars to 38.99 million dollars in 2023, on the back of rapid urbanization, increasing purchasing power, expanding urban population and deteriorating air quality

• Service: The Company aims to offer the best in class products to customers and gives utmost priority to good customer care and service. For this purpose, the Company has also undertaken multiple service-oriented initiatives such as free service camp providing discounted service in pre-summer, customer delight program as well as free product check-up in offseason. Company retain its client base and provides service to over 1,500,000 customers

Research & Development Center

Global Development Center:
• The new Global Development Center (GDC), which is currently under construction, will increase the Company’s product development capabilities, particularly in commercial package air conditioning and residential air conditioning systems
• Located adjacent to the Company’s factory in Karannagar, Kadi, this development center will consist of office space of 6,600 square meters, and multiple labs spread over 12,000 square meters of floor space. These labs will include state-of-the-art research and testing facilities for measuring performance, reliability and electromagnetic compliance
• The facilities will allow for testing of air conditioners for global requirements in ambient temperatures ranging from -40 degrees C to + 60 degrees C
• New GDC will focus on developing residential and packaged air conditioner products for India, Southeast Asia, the Middle East, and EU markets. In addition, a range of capabilities related to user experience, industrial design, simulation, controls, design quality, project management, and engineering information systems will be established at the new center

Brand Value

• Backed by Strong Brand, Offering Inspiring Home & Life Solutions Increase in number of institutional buyers: While room Air-Conditioners (AC) are mainly sold to individuals, there is a large market for institutional buyers in this segment

Channel Expansion:
• In order to widen its reach to Tier II & Tier III cities, the company has expanded its distribution network in these towns through direct dealers and distributors; and today caters to more than 4,000 outlets. With more than 10,000 selling points across 1,350 cities and towns across India. B2C sales network which is supported by a strong team of more than 100 members. It also also partnered with more than 500 distributors in the PAC segment and more than 200 distributors in the VRF segments, to enhance the B2B presence in more than 140 cities across India.
• Growth of e-commerce retail portals and increasing nos. of organized retail formats in Tier II and III towns are going to create good growth opportunity for Room Air Conditioners category
• Smart city projects, High-Rise Buildings, Shopping Complexes, Malls, Hypermarkets now Penetrating in Tier 2 Cities as well are going to increase demand for air-conditioning business. Company is focusing and leveraging the strength of our channel partners
• Various government projects like Metro Rail, Airports, and High-Speed Trains, etc. are going to open big opportunity for commercial air-conditioning segment
• Increasing standards of Bureau of Energy Efficiency (BEE) for energy efficiency in products and focus on promoting Inverter Air Conditioners is a huge opportunity for companies

Strong technological support from the parent: HHLI has been sourcing advanced technology from its Japanese parent which has enabled it to launch superior products in the Indian market. “Hitachi” enjoys a strong brand pull, which has helped the company to steadily grow its market share in India. We expect the company to successfully leverage both, the technical support and brand strength, to grow in India.

Shareholding
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Shareholders have not been meaningfully diluted in the past year.

Covid 19- Risks

• Demand Issue: Customers may postpone their buy due to uncertainty in job and business environment. Customers willing to buy may not be able to purchase due to lockdown or restrictions in movement of goods and services

• Financing Issue: Customers may not buy due to unavailability or increased scrutiny while buying via easy financing and credit options

• Supply Chain: Movement of goods and exports may take a hit as ports and cargo are shut or restricted. Labor or workforce restricted movement may not allow the company to be fully operational

• Closure of Public entertainment places and Industries: Temporary closure of public and entertainment places may impact the sales and services of HVAC systems. Future projects such as the expansion of malls, industries, and smart cities may be impacted in the short term

Covid19- Opportunities

• Export: Japan is giving incentives to Japanese companies for shifting out of China. Considering the GDC is fully operational leading to expanding the export business and targeting South Asian and EU countries

• Strong Residential Demand: Considering the number of employees will start working from home, home appliances will be in demand. The demand may not be there immediately in the short term

• Strong Research and Development Center: Strong backing by the parent company with sharing of technology may help the company to produce superior and sustainable products

• Sustainable Products: George Oliver – Chairman and Chief Executive Officer of Johnson Controls recently said that “More resilient or flexible building space will be required to adapt to changing capacity or utilization needs. Safer environments will be created through seamless combinations of occupant screening, tracing and credential management, and more sophisticated ventilation systems. Touchless or frictionless access, lighting, and temperature controls will be implemented to minimize cross-contamination and enhance the user experience. Remote monitoring and service delivery, including condition-based maintenance, will significantly increase. These types of solutions are being deployed in some of our marquee projects today, and the list of ideas and offerings continues to expand”. This may drive innovation and implementation of new products launched in shopping malls, theatres, etc.

Valuations

Profit and Loss
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9m results for FY20
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• The total revenue generated from exports of Cooling products for comfort and commercial is approximately 3%. The revenue from exports will be increasing due to operational of new manufacturing units
• The design and development service (Research and Development center) generates approximately 75% of revenue by exporting the technology
• JCHAC’s dividend (0.066%) isn’t notable compared to the bottom 25% of dividend payers in the Indian market (0.87%).
• JCHAC is richly value based on its PE Ratio (51.9x) compared to the Consumer Durables industry average (18.1x). It has historically enjoyed rich valuation due to quality of management, debt-free and strong support from parent company
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• JCHAC is overvalued based on its PB Ratio (7.2x) compared to the IN Consumer Durables industry average (1.3x)

Balance Sheet
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• JCHAC’s short term assets (₹7.5B) exceed its short term liabilities (₹4.6B).
• JCHAC has no debt, therefore it does not need to be covered by operating cash flow
• JCHAC has no debt, therefore coverage of interest payments is not a concern.

Cash Flow
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Strength

  • Home appliance products are premium products to target upper SEC customers
  • Low price entry products launched to compete with Blue Star and Voltas with an
    increase in advertising spend
  • Superior Technology compared and R&D services
  • No dependency on China or any other countries for importing spare parts
  • Strong sales and services

Weakness

  • Low brand visibility and recall
  • No major tie-up with multi-chain retailers
  • Royalty Payments made to the parent company
  • Tough competition from local players in AC segment i.e. Blue Star, Voltas, Lloyd

Competitive Analysis

Blue Star: It has a 12% Market share in Air Conditioners and a 25% share in Inverter AC.
As per the management before Covid-19, there was no major demand impact of the company’s AC due to low-priced entry-level products i.e. Unitary Cooling Products and there is likely to be visible price rationalizing with no inventory overhang present. The focus of the management will be in the Tier- 2, 3 & 4 cities with online sales for certain products like water purifiers to also be launched. The company generates 6% of its revenue from online sales.
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The revenue generated from HVAC is approximately 52% and from the sale of the domestic air conditioner is approximately 42%. Inverter-based room-ACs comprised ~45% of room ACs and ~47% of Blue Star’s room-AC revenues

International orders inflow and execution from Dubai and Qatar are seeing good traction with order visibility from SAARC and African countries in the Electro-Mech Projects and Packaged AC systems. The management stated that it is seeing good traction from hospitality and rail orders.

Shareholding

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Promoter holding is low and float is high which impacts share price volatility in the short run.

Valuations

Profit & Loss
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9-month results of FY20
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• Blue Star dividend (2.09%) is higher than the bottom 25% of dividend payers in the Indian market (0.87%)
• Blue Star is undervalued based on its PB Ratio (5.3x) compared to the Consumer Durables industry average (18.1x)
• Blue Star is currently value on its PE Ratio (21.5x) compared to the Consumer Durables industry average (18.1x). Blue Star has 5-year median PE is 41.

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Balance Sheet
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• The past five years have seen Blue Star’s margin expand, due to 32.64% in average net income growth surpassing 9.68% in average revenue growth, which suggests that the company has been able to convert a larger percentage of revenue into net income whilst the growth in their top line
• Debt is well covered by operating cash flow (150.8%)
• Interest payments on its debt are well covered by EBIT

Strength

  • Brand visibility and recall
  • Presence in multi retailers and individual outlets
  • Reasonable pricing
  • Strong sales and services

Weakness

  • Components such as compressors, there was still a dependence on markets like China
  • Revenue dependency on the hospitality industry and Govt of India Infra projects which may be impacted due to Covid-19
  • The company continues to face slowdown from real estate and infra space resulting in order inflow de-growth of ~20%
  • Liquidity crunch (debt- INR 3.96b) and have plans to raise NCD’s to meet capital expenditure and other expenses. This has aggravated due to Covid-19 issues and weak demand outlook in the first half of FY21

Conclusion

Johnson controls may increase their market share by having more pricing power and reach due to its non-dependence on importing spare parts. The cash-rich company may not be highly impacted as compared to its peers in the short term as demand outlook will be weak. The enhanced manufacturing capacity may help increase its exports to South East Asia, Middle East, Africa, and EU countries.

The company has always traded at high valuation compared to its peers and may do well in the near future considering the enhanced product mix, branding, increased manufacturing capacity, and increasing export business.

Disclosure: Invested - 0.5% of the portfolio

References

https://www.screener.in/

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Good attempt if it first one. Any view on following points:

  1. Any insight into outsourcing production? The coil is critical for AC functioning and hence copper cost is moderately large element of cost profile.
  2. How Hitachi group operates in India? Does it have fully owned subsidiary and what are their businesses? By anyway they conflict with listed compnay business?
  3. Whether you own any stock as on date? Please state your position in the company. In case you do not have any investment, please mention that as well in disclosure.

The comments are more to bring thread in line with other threads and improve understanding rather than criticism. In first attempt, you have done excellent job. Appreciate your efforts. :ok_hand:

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Thanks, Dhiraj for your inputs. It is the first attempt

  1. It seems they are not outsourcing after the new plant got functional. Earlier Amber enterprises use to manufacture.
  2. Yes, the fluctuation in raw material prices is a risk.
  3. It’s a joint venture between the US-based Johnson Controls and Japan-based, Hitachi Appliances. They together own 74.25% of the company. All the products are sold under the brand name of Hitachi. There is no conflict with the Indian subsidiary, however, royalty payments are made to both the parent companies in March 2018 and March 2019.
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Hi
Does anyone have the Philip capital Jan 2020 report on Johnson controls hitachi? Or any recent one?

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I have been working on JCHAC; some initial thoughts-

  1. Company does not converts its profits into cashflows. Long term average has been only 60% and going forward also the conversion is going to be low.
    The reasons for the same are-
  • Its a low margin business (~6%) with high working capital requirement (~20% of sales).
  • March to May is the primary season in which nearly 66% sales happen. So towards the end of March there is always a build up of working capital.
  • So assuming the business is looking to grow 10% in next year, there will be 10% increase in working capital towards the end of March compared to same period last year.
  • 10% increase in working capital is around 2% of sales (20%10%), which is like 33% of our Cash profits margins of ~6%. So cash conversion is limited to just 4% of sales ie. 60-65% profits gets converted to cashflows in the end of the year.
    For example- Sales for a year is Rs100, Cash profits is Rs6 and Starting Working capital is Rs20. Next year business is looking to grow 10%. So increase in Working capital would be Rs2 (20    10%) ie, Rs 22 working capital will be there towards the end of year.
    So your cash conversion here is just Rs6 - Rs2 ie. Rs4, which is 66% of your Rs6 profits.
    (Note: this is not exact point-to-point math, but this is what is happening here over say a block of years)
  1. Lower margins also makes risk of operating leverage high. Here the Gross margins are 35% and PBT margins are 6%. So remaining costs are around 30%. So even if costs increases by say 10%, ie. this 30% become 33%, half of the margin goes away and so does profits.
    It is always little risky to bet on companies wherein the margins are very low and the costs between Gross profit and PBT are high.

(Have not given any thoughts to the growth prospects of the company as the business economics did not looked interesting)

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I agree with some points made by you here regarding low margins and cash flow conversions.

Traditionally white goods business is of low margins due to very high competition from marque brands in the market and air conditioners are no different.

The few points I would like to make are

  1. AC penetration in India is around 8-10%.
  2. There is strong tailwind and runway for AC companies as India’s hot weather is here to stay due to various reasons. Penetration will go up as affordability increases.
  3. Over last 10 years the company is able to increase sales from 600r to 2200cr, with capex of 600cr. Going forward as the company achieves critical mass in terms of sales, the asset turns will improve further and more sales will be done from existing asset base.
  4. The company has come out with VRF technology which gives it good competitive advantage.

This company cannot be valued on traditional PE multiple valuation models. Here one needs to value it on Market cap to sales. Margins will improve over time and that in turn will improve cash flows and low capex requirements will improve return ratios going forward.

Disc: Invested

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True, and Hitachi along with its listed peers Voltas & Bluestar get most of their revenues from commercial cooling segment, as the consumer market is very small in size. So, securing higher margin is almost an elusive task for these players.

The only high margin White Good manufacturer is Whirlpool (only 3% AC market share) which doesn’t focus on the commercial segment.

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Why are low margins a problem if the asset turns are high?

On a fixed assets base of 100 Cr, a good brand can generate 600 Cr room AC sales at 10% EBIT margin. At a working capital cycle of 70 days that calls for a working capital investment of 120 Cr. ROCE will still be 20%+

All well known room AC players are growing sales at 12-15% range. Blue Star has the highest investment into both adverts and R&D, if not for these their EBIT % in the Unitary products division can easily be 14-15%. As is the case with any consumer brand, advert investments do not scale linearly with revenue and there is good scope for improvement in margins over the medium term. At AC penetration levels of around 6% in India, the growth runway is indeed long. The problem plaguing the industry is the seasonality of AC sales, Q4 and Q1 make up the bulk of sales in any FY.

Category expansion (water purifiers, air purifiers, other white goods) and improvement in margins will be the key parameters to watch out for. Scale does not enhance manufacturing margins but can spread advert and R&D spends across more units and improve unit economics significantly from here.

Disclosure: Tracking, not invested

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The results FY20 were not that great considering lockdown during the peak sales period. The competitive advantage for JCHAC, the manufacturing of compressors is 100% in their facility in India. For Voltas and Blue star, the compressor is imported from China, considering the current Covid19 scenario and potential trade restrictions from China, their input cost may be impacted. JCHAC may also increase its exports in the coming months which the management had said in one of the interviews in May (Coronavirus lockdown 3.0 | Johnson Controls-Hitachi AC India resumes operations).

The management commentary is not very encouraging and recovery is only from Sept quarter.

20200623_Results_31032020.pdf (4.6 MB)

JCHAC_23062020170842_20200623_CoVID19_Impact.pdf (140.8 KB)

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I think the statement that JCHAC manufactures 100% of its compressor itself in India is not fully correct.

Raw Materials consumed lists Compressor as a product, so it should be a complete unit which they are using. Plus, they import 50% of there raw materials which includes compressors as well. So we need a more credible source for the confirming the same.

If anyone has some credible source highlighting this fact, please do share.

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Quite honest and straightforward answer by the India MD. Business will be down and this year seems to be all about playing catchup. Wondering should i buy more ?

[https://youtu.be/879e4k8sAtk](https://youtu.be/879e4k8sAtk)
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I agree, he kind of mentioned that HYFY21 to be a washout. I would wait for the June quarter results and commentary to decide for further accumulation.

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Agree…I could not find these details in the latest reports. However , the CEO in recent interview said there is dependency on imports of spare parts from China. He also mentioned they may start looking to manufacture these spare parts in India.

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Anyone having insight that why did US based Johnson control partnered with Japan based Hitachi to sell a fraction of the entire Hitachi electronics range (only cooling solutions) in India?

What role does Johnson control play here and what does Hitachi and does the Indian subsidiary of both of these companies pay royalty to both?

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Lot of equations are changing with this news item. Imports of ACs with refrigants are banned. Does this impact BlueStar and Voltas components import? The ban on imports provide a huge opportunity but does Hitachi have the capability to meet the renewed demand and manage the costs in low margin business?

Disc: Tracking. Undecided between Hitachi and Bluestar

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Hi,

A good, short read about the business model and imports
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Thanks,
Deb

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Positives:

Focus on gaining market share
Targeting to reach a revenue to Rs4000 cr by 2024 and achieve market share of 18%.

One of the few exporters of RACs from India

JCHAC is one of the first movers in exports, exporting its India-made products for the past six years and intending to scale it up, going forward.
JCHAC expects to increase the proportion of exports from the current 5.5% to 10% by 2024.

Most of the components for RAC industry in India are imported from China. JCHAC is favorably placed in light of this anticipated policy change, as it has already tied up for raw material sourcing with its group companies in India and overseas.

Production Linked Incentive (PLI) scheme can help drive growth

Huge industrial growth potential

Recent ban on import of ACs with refrigerants to help local manufacturers/assemblers

Negatives:

“The summer season is a crucial part of the consumer durable and appliances industry. The February to June period contributes to ~60% of the total industry’s turnover; JCHAC also generates ~43% of revenue in Q1, which indicates that most of the revenue comes from this period only. March and April contribute 12% each towards sales turnover in the industry.”

With lockdown in many states their will be revenue degrowth.

Competitive and fragmented industry

The air conditioning segment is fragmented with 25 well-known players, including Indian and global corporates, with the top five players accounting for ~60% of the market share.

Attached a very good report from HDFC.

Initiating Coverage - JCHAC 160321.pdf (1.2 MB)

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PLI is not for finished good AC…it is for raw materials…so may significantly benefit the suppliers which may Indirectly benefit AC makers little bit only.
If scheme is extented to finished goods, can benefit AC makers significantly.