Reporting a 10% increase year over year for the second quarter, Honeywell International's (NASDAQ:HON) diluted EPS of $1.66 was in line with the high end of its forecast. Still, there's more to the company's quarter than just one figure. Let's dig in deeper to gain a better understanding of how the company fared overall.
ABCs of ACS
Honeywell's automation and control solutions (ACS) segment reported the greatest revenue growth -- 9% year over year -- among its three operating segments, but the segment also reported a 20 basis point (bps) contraction in segment margin. Excluding merger and acquisition costs, though, the segment would have reported a 50 bps expansion in segment margin.
Most interesting, though, was the news that ACS will be divided into two operating segments: safety and productivity solutions (SPS) and home and building technologies (HBT). According to management, the division will lead to greater efficiencies as the company strives to further integrate the many acquisitions -- totaling more than $6 billion -- it has completed in the last year. The company will report its third-quarter earnings based on this realignment.
The other noteworthy item from ACS this past quarter was the company's acquisition of Intelligrated, a provider of complete warehouse automation solutions. Integrated into the new SPS segment, the $1.5 billion acquisition is expected to close during the third quarter and complement Honeywell's current automation solutions. Intelligrated is expected to report approximately $900 million in revenue for 2016, but once it is fully integrated, Honewell will present significant competition to industry leaders like Rockwell Automation, which reported $6.3 billion in revenue, according to Morningstar.
Growing pains aren't so painful
Meeting management's expectations, the company reported a 2% year-over-year decline in core organic growth. Performance material and technologies struggled the most out of the three operating segments; it reported a 4% decline in core organic growth -- mostly a result of continuing weakness in the oil and gas industry.
Despite all of this, management is forecasting overall core organic growth of 1% for fiscal 2016.
One concern with companies that mostly seek growth through acquisitions is whether that strategy is sustainable. If the acquisitions are financed through debt, management must be adept at handling the ever-growing debt load. If the company is seeking to finance acquisitions with cash, it begs the question: Does the company have the cash available?
Clearly, over the past five years, Honeywell's management has demonstrated its proficiency in identifying and completing acquisitions while maintaining sound financial health. According to Morningstar, from 2011 to 2015, Honeywell has increased its capital expenditures spending by 35% -- from $798 million to $1.1 billion. And in that time, the company has maintained its ability to churn out cash, growing its free cash flow 115% -- from $2.04 billion in 2011 to $4.38 billion in 2015. Management doesn't expect the flow to ebb anytime soon; it's forecasting free cash flow growth between 5% and 10% for fiscal 2016.
A dash of salt
Although Honeywell met its target and reported diluted EPS of $1.66, this can't be taken at face value. For one, the 10% improvement year over year in diluted EPS is inconsistent with the company's 2% growth in sales. Ideally, the earnings growth would be commensurate with revenue growth. So, how did the company do it?
Management followed through on its share repurchase plan and bought back $477 million in outstanding shares during the quarter, resulting in about 763 million shares outstanding at the end of the quarter -- about 2.6% lower than the 783 million it had at the end of Q2 2015. If the company had ended this past quarter with the share count it had at the same time last year, the EPS for this past quarter would've been about $0.04 lower. It may seem like only pennies, but the market is notorious for punishing companies that miss estimates by that much.
According to Honeywell's 10-Q, the company has plenty of room left to continue boosting its EPS by buying back shares. Of a $5 billion stock buyback plan, "$4.5 billion remained available as of June 30, 2016 for additional share repurchases." Consequently, investors should be cautious about blindly accepting the EPS figures -- balancing the earnings figure with a look to see if there was a share buyback.
Honeywell appears to have had a successful quarter, but as we've seen, there's much more to a company's quarterly performance than just one figure. In addition to looking at the past three months, management suggested its future would continue to be bright. During the earnings report, it provided a revision on its fiscal 2016 guidance: upwardly raising -- by $0.10 -- the lower end of its EPS estimate to provide a new range of $6.60 to $6.70. Should the company meet this estimate, investors should be circumspect and dig deeper into the financials. Did revenue increase at a comparable rate? Did organic sales improve? Was there a share repurchase plan executed? These are just some of the many questions for investors to consider.