Shares of Honeywell slid Thursday as strong second-quarter results are being overshadowed by a mixed update to management’s outlook for the remainder of the year. But we’re looking through the weakness on a belief that the industrial conglomerate is heading toward a healthy 2025.
- Revenue for the three months ended June 30 totaled $9.58 billion, topping Wall Street expectations of $9.41 billion, according to estimates compiled by LSEG.
- Adjusted earnings per share of $2.49 advanced roughly 8% compared with the year-ago period, ahead of the $2.42 consensus forecast, LSEG data showed. It also came in above the high end of management’s guidance.
- Segment margin, similar to an adjusted operating income margin, expanded about half a percentage point on an annual basis to 23%, slightly below expectations but in line with management’s previously forecasted range.
- Why we own it: Honeywell is a provider of industrial technology solutions to companies in various industries. We appreciate its exposure to the aerospace industry as a parts supplier. The portfolio has, however, become a bit bloated. We think further upside will come as the company divests non-core businesses and focuses both internal investments and acquisition efforts around management’s three targeted mega-trends: automation, the future of aviation, and the energy transition.
Competitors: Emerson Electric, RTX, 3M
Weight in portfolio: 3.14%
Most recent buy: April 10, 2024
Initiated: July 5, 2020
Bottom line
Honeywell’s actual results were strong. The nearly 5% decline in the stock is all about the company’s more subdued outlook.
Second-quarter sales, earnings, organic growth and cash flow all outpaced expectations, with quality performance across Honeywell’s four operating segments. Its overall segment profit margin came up slightly short, but the weakness there is entirely attributable to a miss in Aerospace Technologies profitability.
But here’s the root of Thursday’s selling: Honeywell downwardly revised its full-year guidance for segment margin, earnings per share, and cash flow guidance. The changes are tied to the inclusion of previously closed and announced acquisitions, as well as a slower-than expected-rebound for short-cycle businesses. That is carrying much more weight than the bump to Honeywell’s full-year sales outlook and the low end of its organic sales growth forecast.
Management had been clear that the swing factor for achieving the higher end of its previous guidance was the pace of a rebound for short-cycle businesses, which tend to be more profitable. Unfortunately, despite some “pockets of short-cycle strength,” other short-cycle businesses “are not accelerating as much as we had hoped,” CFO Greg Lewis said on the call.
- For context, long-cycle businesses are less sensitive to near-term economic conditions since there’s a lengthier period between when order placement and delivery. Aerospace is a good example.
- Honeywell’s building products unit, which includes offerings like fire-protection systems, is an example of short-cycle business.
Obviously, this is not an ideal forecast. But we still walk away from the report believing things are getting better — even with the obstacles in short-cycle areas and the signs that other investors are throwing in the towel.
Supply chain dynamics are improving, and profitability is expected to rebound as we work our way into next year. Moreover, management is hard at work executing on CEO Vimal Kapur’s vision of better aligning the overall business to the megatrends of automation, the future of aviation, and energy transition.
Following Thursday’s report and guidance revisions, we are reiterating our price target of $225 a share as we see a favorable setup for 2025 and anticipate a stronger rebound in the short-cycle businesses. We also reaffirm our 2 rating as we look for a better entry point below the $200-per-share level.
Guidance
Looking at the guidance table above, management’s outlook for the current quarter — its fiscal 2024 third quarter — was mixed. Sales were guided to be better than expected, though profitability came up short of Wall Street estimates.
- On the call, Honeywell executives said the third quarter is expected to be the low point of the year for segment margins, “reflecting the closing of [defense firm] CAES and less favorable quarterly mix.”
- But the situation is set to improve. “In Industrial Automation, we’re benefiting from solid orders, momentum in most of our long-cycle businesses, while our short-cycle businesses are showing varying signs of sequential progress,” finance chief Lewis said. “In the third quarter, we expect modest sequential improvement in [Industrial Automation] and a return to year-over-year growth in the back half.”
On a full-year basis, management’s boosted its sales and organic growth outlook. However, its forecast for segment margin, earnings and cash flow were all revised lower.
- These updates reflect the impact of Honeywell’s $5 billion acquisition of Carrier’s Global Access Solutions business, which closed in June, and two previously announced acquisitions expected to close in the third quarter: the $1.9 billion purchase of CAES Systems Holdings and the $1.8 billion acquisition of Air Products’ LNG Business.
- Of the 15-cent reduction to the midpoint of the team’s full-year adjusted earnings guide, roughly one-third (5 cents) is attributable to acquisition-related costs. The other two-thirds (10 cents) are attributable to the sales mix as less profitable long-cycle businesses are outgrowing short-cycle businesses.
- “While we are encouraged by our performance year to date and our robust backlog, the back half will remain influenced by the dynamic macroeconomic backdrop and varying levels of channel improvement across our portfolio,” Lewis said on the call.
Quarterly commentary
As we can see above, a slight miss in Aerospace Technologies profitability due to the sales mix was the only real miss in the reported results and dragged down the companywide segment margin. Even still, actual Aerospace segment profit dollars came in ahead of expectations thanks to its strong topline performance.
Aerospace continued to lead the way for organic growth, which management expects to continue throughout the year. Honeywell anticipates the second quarter “to be our low point of the year for growth as some related supply chain challenges abate,” Lewis said.
- Aerospace benefited from double-digit growth in both the defense and space, and commercial aviation, the latter of which realized its 13th consecutive quarter of double-digit growth. Equally important, the supply chain continues to improve, with output increasing 14% in the second quarter.
Industrial Automation sales were hampered by volume declines in warehouse and workflow solutions, though overall sales were up 1% compared with the first quarter. Sales in productivity solutions and services declined on a reported basis. However, they were up year over year and sequentially when “excluding the impact of payments under the license and settlement agreement that ended in the first quarter,” according to a press release. Sensing and safety technologies business sales were down compared with the year-ago period, though orders and sales improved sequentially. The segment’s book-to-bill came in at 1.1. A book-to-bill ratio measures the amount of business booked versus the amount billed. The higher the ratio, the better because it means that demand is exceeding supply and resulting in backlog growth.
Building Automation sales were up only 1% organically year over year. But they increased 10% sequentially when including the one-month contribution of Carrier’s Global Access Solutions operations. The book-to-bill ratio came in at 1.1 for the segment.
In Energy and Sustainability Solutions, overall sales growth was led by 8% growth in advanced materials. However, sales in UOP, its petrochemicals business, fell 4% due “difficult year-over-year comps from large gas processing equipment projects, partially offset by growth in refining catalysts and aftermarket services,” the company said in a release. The book-to-bill ratio came in at 1.2 for the segment.
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