Honeywell Is Poised For Acceleration, Or Is It? (NASDAQ:HON)

Honeywell International Inc. (NASDAQ:HON) is a leading software-industrial company that has undergone a significant transformation and is now poised for accelerated growth and earnings, according to management. Investors are optimistic about the company’s prospects, resulting in significant outperformance of the stock. Is the stock worth its premium valuation?

In this article, we will systematically examine the company’s business fundamentals, strategy, risks, financials and valuation to help readers arrive at a more informed position to assess the risk and rewards of owning the stock.

Note: This article is for educational purposes only and does not constitute financial or investment advice. Please do your own due diligence and consider your unique financial needs and constraints before buying any stock.

Business Overview

Honeywell International is a leading software-industrial company that invents and commercializes technologies that address some of the world’s most critical challenges around energy, safety, security, air travel, productivity, and global urbanization. The company is committed to introducing cutting-edge technology solutions to improve efficiency, productivity, sustainability, and safety in high-growth businesses in diverse industrial end markets.

As a diversified technology and manufacturing company, Honeywell is uniquely positioned to combine physical products with software to serve customers worldwide with aerospace products and services, energy-efficient products and solutions for businesses, specialty chemicals, electronic and advanced materials, process technology for refining and petrochemicals, and productivity, sensing, safety and security technologies for buildings and industries. The Honeywell brand dates back to 1906, and the company was incorporated in Delaware in 1985.

Business Objectives: Honeywell aims to drive profitable growth by focusing on innovation and expanding in high-growth regions. The company also seeks to become a leading software-industrial company by expanding its digital transformation solution, Honeywell Forge. Additionally, Honeywell is committed to expanding margins through various optimization initiatives and commercial excellence, as well as executing disciplined portfolio management for growth and shareholder value. The company also aims to control costs related to asbestos, environmental matters, and post-retirement benefits. Honeywell plans to increase available capital for strategic deployment in acquisitions, dividends, share repurchases, and capital expenditures. Lastly, Honeywell is committed to upholding environmental, social, and governance principles as a responsible corporate citizen.

Looking Forward

We believe management’s initiative to accelerate HON’s growth and enhance its margin profile should position the company well going forward. Over the past several years, Honeywell has intensified its efforts on three key transformation initiatives. The company has strategically allocated capital to optimize its portfolio, foster a culture of innovation, and take a leadership position in environmental, social, and governance [ESG] objectives. As part of these efforts, the company has completed four acquisitions which have strengthened its portfolio and propelled growth in sustainable technologies.

Based on the most recent industrial data pertaining to Honeywell, it appears that demand in high-growth regions such as India, the Middle East, China, and Southeast Asia is stable. While China experienced a slowdown during the implementation of its zero-COVID policy, the country is anticipated to recover as it reopens. Honeywell’s latest earnings report indicates that the company’s Buildings Enterprise is experiencing mid-teen organic order growth in these regions.

North America growth has decelerated significantly but is still performing well. The company reported 3% organic growth in Q3, but for the year, the growth rate is mid-teens. The reason for this is that customers are giving less lead time now because they know that the supply chain is improving.

Europe is facing some challenges, particularly with the energy transition and some softening in demand, but nothing significant for Honeywell as of yet. However, escalation of the Ukraine ware could quickly change the situation so we advise caution for investors. Europe is the only region being monitored as a yellow flag, while the rest of the world is performing strongly.

We are cautiously optimistic about the trends that will benefit its business moving forward. The company has made significant progress in supply chain transformation and digital transformation, which has served it well in recent years. Honeywell’s end market exposure in aerospace, energy, and sustainable buildings is also expected to be beneficial. The company’s backlog is currently at an all-time high of $29 billion, which should contribute to growth in the coming year.

Shareholders should rejoice at Honeywell’s commitment to returning capital in a more aggressive manner, with a goal of returning $25 billion over the next 3 years.

Digging Deeper: Digital Transformation

Honeywell has made significant progress in its digital transformation journey, greatly improving its visibility and ability to make strategic decisions. We commend the company’s Chief Supply Chain Officer, Torsten Pilz, for changing the supply chain capabilities dramatically in the last 5 years by implementing digital tools that allow for real-time tracking of shipments.

The company is also focusing on resiliency and alternate sources of supply to combat inflation and shortages. Honeywell has also been redesigning its supply chain to reduce physical complexity and risk. The company has also been working on instrumenting its planning system throughout the network and driving automation in its own facilities.

These efforts have made the company’s supply chain much different from where it was 5 years ago, and there is still more work to be done.

Digging Deeper: Buildings

Honeywell is actively participating in urbanization projects in high-growth regions such as the Middle East, particularly in Egypt, where they are developing new cities.

Urbanization has been a secular trend for a long time in China and other high-growth regions. However, it is particularly interesting that these regions are now actively investing in greening their built environment and commercial buildings. This includes implementing technology to manage carbon commitments and prioritize sustainability. This trend is powerful in China and the Middle East, and it is driven by the fact that these regions have a bias toward new construction, which makes the adoption of new technology more straightforward.

The company has also invested in a new business unit to prioritize sustainable buildings in high-growth regions, as they are leading the charge in this area.

We observe the macro data in places like Europe is beginning to show some signs of weakness, particularly in the private investment sector such as commercial and residential real estate. However, institutional demand for building upgrades and retrofits is actually increasing. This is primarily due to the fact that institutional buildings are generally owner-operated and they are very concerned about energy costs and sustainability objectives imposed by governments.

This is evident in the various energy consumption and building codes and standards being implemented by regional governments. Additionally, there is a significant amount of stimulus investment in the pipeline for projects such as K-12 schools in the U.S. and hospitals in Italy, which is contributing to the robustness of institutional demand. As a significant portion of Honeywell’s business is focused on institutional buildings, this trend is expected to buffer the company from any potential weakness in the private construction sector.

Risks

Honeywell currently trades at a premium to the market, despite posting mediocre financial results. Investors are bullish about the company’s growth potential following its transformation efforts. However, the company’s complex portfolio of businesses across various end markets, and its ongoing reshaping of the portfolio through mergers and acquisitions and divestitures, makes it difficult to understand the extent of its growth and transformation fully. This can leave investors dependent on their trust in management’s ability to execute on their strategy.

Financials & Valuation

Revenue: Over the past three fiscal years, HON’s revenue has grown at a compound annual growth rate of -6.3%. This reflects the difficult period HON went through which included an industrial recession and COVID. However, analysts forecast revenue growth of 3.3% for the current fiscal year, reaching $35.5 billion, and 4.1% for the next fiscal year, reaching $37.0 billion. This acceleration in growth reflects HON’s strong backlog, expected easing of supply chain constraint, and the transformation of its business.

Earnings: EBIT margin has also increased by 1.4% points over the past three years, from 19.6% to 21.0%. Consensus estimates predict a further expansion of 128 basis points to 22.2% for the current fiscal year and 13 basis points to 22.4% for the next fiscal year. EPS growth at a compound annual growth rate of 0.2% over the past three fiscal years. Going forward, analysts forecast EPS to increase by 8.5% to $8.74 for the current fiscal year and 4.7% to $9.15 for the next fiscal year. The same drivers of the company’s revenue acceleration are also expected to drive its EPS growth acceleration.

Balance Sheet: HON has a net debt of $9.3 billion and a current-year EBITDA of $9.0 billion, resulting in a leverage ratio of 1.0 times. This is rather low for an industrial company, suggesting that HON has plenty of capital to deploy to acquire companies.

Valuation: HON’s stock currently trades at $216.61 per share, giving it a market value of $145.6 billion and an enterprise value of $154.9 billion. The dividend yield is 1.9%, higher than the S&P 500’s yield by 32 basis points.

HON is trading at an EV/Sales multiple of 4.2, an EV/EBIT multiple of 18.7, a P/E multiple of 23.7, and a FCF multiple of 25.7. These multiples are higher than the S&P 500’s multiples by 88.7%, 17.7%, 36.8%, and 27.4%, respectively. The company’s PEG ratio for next fiscal year is 2.6, compared to the S&P 500’s PEG ratio of 1.6, indicating a premium of 60.4%.

Despite posting underwhelming financial results, HON outperformed the S&P 500 by a considerable margin over the past year. At present, HON is trading at a premium in comparison to the market. Investors are optimistic that the company’s recent transformation will lead to increased growth in the future. However, it is important to note that potential results are uncertain and actual outcomes may indicate that the premium is unjustified.

Conclusion

HON operates in a diverse range of businesses and end markets across the globe, making it challenging for investors to fully understand the company’s growth prospects and business transformation efforts. The company’s ongoing portfolio reshaping through mergers and acquisitions and divestitures further adds to this complexity. Despite posting mediocre financial results, the stock has performed well and trades at a premium to the market. As a result, it may be prudent for investors to adopt a “wait and see” approach and gather more information before making a decision on the stock.