Tyco Posts Positive Results Despite Macro Headwinds

Tyco reported strong fiscal second-quarter results in the face of continued weakness in global commercial construction. The security and fire firm increased year-overyear organic revenue by 2% in the quarter, a slight acceleration from 1% growth in the prior quarter. Increased project selectivity in North America commercial security curbed revenue from growing further, but the company should see better growth from higher-margin service revenue in the years ahead.

Tyco maintained its revenue guidance for the full year (ending September) but increased the low end of its earnings per share guidance by $0.05, to $1.80-$1.85. We believe earnings should come near the high end of guidance, given the solid first-half results and margin benefits expected from accelerated restructuring. Considering Tyco’s solid execution post-spin-off, we have lowered its cost of equity and weighted average cost of capital closer to its security and diversified industrial peers.

A lower discount rate, along with time value of money benefits and slight upward revisions to our forecast for North America installation and services segment revenue and margins, results in a $5 increase in our fair value estimate, to $35 per share. Our narrow economic moat rating is unchanged.

Tyco delivered an impressive second quarter. While seemingly all its peers have thus far reported decelerated (and negative) organic growth in the March quarter, Tyco reported accelerated organic revenue growth. North American installation and services (flat) and global products (up 7%) performed above management’s guidance, which we believe is encouraging given the top-line headwinds from the firm’s ongoing efforts to only target North American commercial security projects that will carry higher-margin service revenue. Firmwide segment operating margins expanded 50 basis points despite 40 basis points of dissynergies from the September spin-offs, due to mix shift benefits from less installation revenue and initial tailwinds from restructuring.

We continue to believe Tyco is making the right strategic moves, namely focusing on service revenue acceleration to 5%, especially since fire and security installation is a mature market in North America and Europe (combined 72% of revenue). We also believe Tyco is well positioned to benefit from an eventual recovery in commercial construction, where it has 36% end market exposure.

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