Resideo Technologies – Smart Home, Smart Investment? (NYSE:REZI)

In February of this year, I believed that shares of Resideo Technologies, Inc. (NYSE:REZI) were getting more secure. At the time, the company had seen a strong 2021 after a painful start for the former Honeywell International Inc. (HON) spinoff.

The company has been deleveraging the balance sheet and was improving earnings power, being ready to pursue M&A activity again, as the complicated finances and a somewhat more expensive deal prevented me from pulling the trigger.

A Recap

Resideo is a residential security solutions provider, which was separated from its parent Honeywell late in 2018, with shares initially exchanging hands in their high-twenties. The business is essentially comprised out of two businesses under a single roof.

There is the lower-margin and larger distribution business, and an actual product business which is smaller but posts higher margins. Products one can think of include cameras, heating control, freeze detection, and smart home applications. At the time of the spin-out, the company generated $4.8 billion in sales. EBIT was posted around $420 million, after paying a $140 million indemnification payment to its former parent, a liability to last 25 years into the future from 2018 onwards.

Even after this payment, earnings came in at $2 per share. This looked appealing, yet identified headwinds for 2019, and capital spending set to surpass depreciation charges, were reasons to be cautious. This was furthermore confirmed as some other Honeywell spinoffs had seen tough times at the time.

Late in 2019, the company warned of worsening earnings, triggering shares to fall to the $10 mark, as I had initiated a small speculative position on the back of all the bad news flow. This came as, while 2019 sales rose 3% to $5.0 billion, operating profits were down to just $258 million, resulting in GAAP earnings of just 36 million, or $0.29 per share. While adjusted earnings topped a dollar per share, some adjustments were quite aggressive, with leverage concerns showing up.

The year 2020 was a lost year, which could be expected as sales did still rise 2% to $5.1 billion, with GAAP earnings again posted at $0.29 per share. The underlying results were better than 2019, with operating profits up, as these advancements were offset by a higher tax rate.

The good news was that the company saw a big expected increase in profitability in 2021. Through the first three quarters of 2021 sales rose 23% to $4.4 billion, with the company on track to generate $5.8 billion in sales. The company was on track to post earnings of $1.60 per share as these earnings and a small equity issue made that net debt came down to just over half a billion, roughly equal to the reported EBITDA numbers. This excludes nearly $600 million in indemnification payments, manageable, given their long term tenure.

Back To Early 2022

In February of that year, the 148 million shares traded at $24, having come down from levels in the low thirties. Including debt, the company was valued at $4.0 billion, that is if we include financial debt (and not the Honeywell liabilities). The $1.60 earnings per share number translates into a 15 times multiple, as leverage is under control, albeit that 10% margins are probably quite rich already.

The company announced a rather big deal, paying $593 million to acquire the First Alert business from Newell Brands (NEWL) at the start of the year. The $395 million revenue contribution suggests the purchase price is steeper in terms of sales multiples, to be expected as Resideo Technologies, Inc. itself includes a large and lower-margin distribution business. Net debt would double to $1.1 billion, and while a few pennies’ accretion to the $1.60 per share earnings number might be expected, these earnings are still coming short of the $2 per share run rate at the time of the spinoff.

Sitting on 140% profits from the $10 purchase in 2019, I felt no reason to alter that speculative position, as the volatility and complicated finances made a premium valuation unlikely in the near term.

In February, the company posted its 2021 results and guided for 2022 sales to come in between $5.95 and $6.20 billion on which operating profits were seen between $610-$650 million. This suggests modest growth from a $5.85 billion revenue number in 2021 on which operating profits were posted at $559 million. The incremental $71 million in operating earnings (at the midpoint), suggests that a $1.63 per share number in 2021 could rise towards $2 per share.

2022: First Solid, Soft To The End

Following resilient first quarter results, the company hiked the midpoint of the sales guidance to $6.55 billion with operating earnings seen around $700 million. The company maintained the sales guidance and hiked the midpoint of the operating earnings guidance to $705 million following the second quarter earnings release. Net debt stood at $1.17 billion by quarter’s end.

There was a shock when the third quarter results were released with quarterly earnings down four cents (on an annual basis) to $0.42 per share. This was mostly due to gross margin pressure at the products and service business and a slightly higher effective tax rate, with net debt stable on a sequential basis at $1.17 billion. The company cut the midpoint of the sales guidance to $6.385 billion with operating profits now seen at $650 million, still seen at the higher end of the initial guidance for the year, with working capital management not being too impressive.

Despite the poor outlook, earnings are still seen around $2 per share. With shares now down to $16 per share, expectations remain very modest at 8 times earnings. The issue is that regular debt is manageable but increased a bit this year, as the long term litigation liabilities to Honeywell remain, still valued at $575 million on the balance sheet. Another issue is that the $2 earnings per share run rate is under pressure, with fourth quarter earnings expected to face continued pressure.

And Now?

Right now I see appeal increasing for Resideo Technologies, Inc. shares, yet I feel some nerves to increase my long position. The complicated balance sheet remains an issue, as Resideo Technologies, Inc. has been incurring some debt to fuel growth, yet earnings are still stuck around $2 per share. Amidst all of this, I see no reason to alter my current long position, looking to sell Resideo Technologies, Inc. in case valuation multiples expand to somewhat more demanding multiples.