Johnson Controls Waxes & Wanes

Johnson Controls, Inc. (NYSE: JCI) seems like it's been trapped on a rollercoaster all this year. Will we see the stock break out to new historical highs, or will it crest the hill to another downward slope? Looking at the driving forces behind this recent push to $42, I'm looking for another go-round.

A leading producer of automotive interiors and batteries, as well as building efficiency solutions, Johnson Controls appears to be coasting on its high beta of 1.88, essentially exaggerating S&P movement over the course of the last 3 months. Apart from the Japanese earthquake disrupting auto production, followed by a handful of analyst upgrades, there appears to be nothing happening to explain the ride. That's our first clue that this recent rally will likely be short-lived.

A vast majority of Johnson Controls' forecasted growth is in its car battery division as the new wave of start-stop hybrid motors demand more powerful (and, coincidentally, more profitable) batteries. Johnson Controls is attempting to set itself up to capitalize on these projections, even going so far as to abandon a lithium battery partnership (for plug-in electric vehicles) to focus on this technology instead.

The problem I see with the beautiful picture Johnson Controls is painting is much more macro-focused. I believe we'll see lower-than-projected new car sales due to the tightening of credit and high unemployment. With little improvement in these areas since 2009, how can we expect normality in dependent industries without first solving (or at least patching) the underlying problem?

If $3-a-gallon gasoline returns, we'll see less consumer focus on efficiency, although government initiatives (in the US and abroad) will likely be unaffected. This would certainly have a negative impact on gas-sipping vehicle sales.

Translating these revised projections to Johnson Control's share price, I arrived at a valuation of $37.15 to $41.96 per share.

To calculate this valuation, I utilized a discounted cash flow approach, accounting for mild growth (12% to 17%), and an upward skew to historically-ranged free cash-flow margins at 0.7% to 2.7%. Johnson Controls actually modeled one of the tightest adherences to the valuation bands that I've seen. This is a very good demonstration of how a lack of material news over a time frame can lead to these types of channel patterns -- where price action is mostly noise.

Essentially, right now, we're on a peak of optimism with Johnson Control's stock. There's been a long run of positive news and high expectations that have had time to propagate down to the share price. Buyers are feeling very comfortable after the quick run-up and have already scheduled their early retirements by drawing their own extrapolations. This is a dangerous spot to be long as the upward momentum wanes.

Consider taking profits at this technical and fundamental valuation ceiling, and be ready to buy again closer to its baseline valuation.

(Disclosure: At the time of this writing, Tony Kau did not have a position in JCI, but the Trend Exhaustion fund he manages did have a short position in JCI.)