Key Points
- The company’s end markets are about to fire on all cylinders.
- The pathway to growth at aerospace is likely to be a multi-year event.
- The stock deserves a rerating based on the growth in its software and high-tech revenue.
Honeywell’s valuation
The first place to start is with the industrial stock’s valuation because it’s hard to make the case that Honeywell is a cheap stock. Across a range of valuation metrics, Honeywell looks more than fully valued. While it’s fair to say that the valuations below are constructed using current earnings and free cash flow (FCF) and therefore reflect the weakness in the economy caused by the pandemic, the reality is Honeywell also looks expensive on the Wall Street analyst consensus for 2022.
IMAGE SOURCE: GETTY IMAGES.
For example, Wall Street has Honeywell trading on an enterprise value (market cap plus net debt), or EV, to earnings before interest, taxation, depreciation, and amortization (EBITDA) of more than 17 times EBITDA in 2022 and a price to a free-cash-flow (FCF) multiple of nearly 26 times FCF. But, again, those are not cheap multiples.
DATA BY YCHARTS
What would make Honeywell a buy
Honeywell will have to do at least two things to justify buying the stock on such a valuation. First, the company has an opportunity to grow its software and quantum-computing revenue. Second, Honeywell has already invested substantially in its software and digital-solutions capability — Honeywell Forge.
Meanwhile, Honeywell recently announced a deal to take a majority stake in a new quantum-computing company that Honeywell CEO Darius Adamczyk believes could generate $1 billon in sales in two to five years. Given that software and high-tech companies tend to command a valuation premium over industrial stocks, these growth initiatives should lead to valuation rerating.
The company also needs to continue its impressive earnings-growth record. Fortunately, there’s ample evidence that Honeywell can do just that.
Why Honeywell can grow earnings
Honeywell has excellent earnings momentum in 2021. You can see this in the upgrading of its full-year guidance as the year has progressed.
| Honeywell International | Current Guidance | April Full-Year Guidance | January Guidance |
|---|---|---|---|
| Sales |
$34.6 billion to $35.2 billion |
$34 billion to $34.8 billion |
$33.4 billion to $34.4 billion |
| Segment margin | 20.8% to 21.1% | 20.7% to 21.1% | 20.7% to 21.1% |
| Adjusted earnings per share |
$7.95 to $8.10 |
$7.75 to $8 |
$7.60 to $8 |
| Free cash flow |
$5.3 billion to $5.6 billion |
$5.2 billion to $5.5 billion |
$5.1 billion to $5.5 billion |
DATA SOURCE: HONEYWELL PRESENTATIONS.
Moreover, Q2 marked the first quarter since Q1 2019 whereby all four of Honeywell’s segments were in growth mode.
DATA SOURCE: HONEYWELL PRESENTATIONS. YOY=YEAR OVER YEAR. CHART BY AUTHOR.
Granted, a large part of Honeywell is in year-over-year growth mode because its segments are coming up against some straightforward comparisons with the pandemic-ravaged year of 2020. But there are still some powerful signs that Honeywell’s about to start firing on all cylinders.
Commercial aviation aftermarket revenue is already recovering from 2020 as flight departures steadily climb back to 2019 levels in the aerospace segment. However, Honeywell still has a long runway of growth ahead as departures continue to grow. Also, at some point, commercial aviation original equipment will grow as airplane manufacturers are looking to ramp up production.
DATA SOURCE: HONEYWELL PRESENTATIONS. YOY=YEAR OVER YEAR. CHART BY AUTHOR.
Management started 2021 believing that Honeywell building technologies (HBT) would generate low single-digit growth for the full year, but that outlook has now been upgraded to mid-single-digit growth. There’s been a debate over whether growth in demand for healthy-buildings solutions, connected buildings, and energy-efficiency solutions would trump headwinds from a slow recovery in the hospitality and commercial office sectors. Still, it looks like that battle is being won.
The performance materials and technologies (PMT) segment is now expected to grow at a low single-digit rate compared to a previous estimate for a range of a low single-digit decline to low single-digit growth. Advanced materials (high-performance products used across a range of industries) is already growing strongly as the economy reopens. Meanwhile, Adamczyk outlined that orders for universal oil products (UOP), like catalysts and absorbents for fuel refiners, tend to lead Honeywell process-solutions (HPS) orders by “twelve to eighteen months.”
Given that UOP orders were up 30% in the second quarter (the price of oil is rising and the reopening economy is encouraging refining demand), it’s highly likely that process-solutions orders will follow in time.
DATA SOURCE: HONEYWELL PRESENTATIONS. YOY=YEAR OVER YEAR. CHART BY AUTHOR.
Is Honeywell a buy?
All told, Honeywell’s valuation probably still looks a bit rich for many investors, but the company continues to outperform operationally and has plenty of long-term earnings drivers. As such, buying stock in Honeywell looks likely to reward investors over the long term, but now may not necessarily be the best time to buy in.
