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Honeywell International (HON 1.36%) is set to report its third-quarter earnings on Oct. 21. Providing a less than rosy picture of what 2017 is expected to bring, Honeywell watched its shares drop 10% in the four days following its filing of a revealing 8-K. This and management's recently revised Q3 guidance of $1.67 in earnings per share (EPS) -- the lower end of the previous guidance range, $1.67 to $1.72 -- still has some investors unnerved. Let's take a look at some things we'll likely hear about when the company reports and how we could interpret them.
Reactions to realignment
One of Honeywell's major initiatives in 2016 has been the realignment of its automation and control solutions (ACS) segment into two new segments: home and building technologies and safety and productivity solutions. According to management, the two new segments will afford the company greater operational efficiency and help to fuel organic growth.
Last quarter, Honeywell reported sales of $3.89 billion for the ACS segment. Though this represents 9% growth year over year, it also represents a 1% decline in core organic sales.
Image source: Honeywell.
Excluding mergers and acquisitions, this translated to a 50 basis points (bps) improvement in the segment margin.
While the company will report earnings under this new structure for the first time in Q3, it will also provide comparative financial information, so we will be able to see if the realignment is providing the benefits that management had suggested. Besides core organic sales growth, investors should also expect to see an improved segment margin.
Up in the air
One facet of the company that has garnered concern recently is its aerospace business. In the second quarter -- dropping below even management's expectations -- sales declined 1% while core organic sales dropped 2%.
Management attributes the decline to various challenges, such as weaker than expected sales in defense and space and weak commercial helicopter sales resulting from a decline in the oil and gas industry. Another factor impacting the segment's sales is the commercial aviation OEM (original equipment manufacturing) incentives that the company is offering. Although they will represent headwinds through 2016 and 2017, they then decrease. Looking to the future, management foresees the incentives turning into a tailwind as they "actually help us to build an install base for service opportunities."
Management is guiding for aerospace sales to be down 1% to up 1% in the third quarter. Investors should monitor this closely to see if -- like last quarter -- the figures are worse than management had expected. It would be shortsighted to solely interpret this as a warning sign of continued decline in the segment, so investors will need to monitor the segment in the coming months to see if the OEM incentives bear the fruit that management is expecting.
Looking for a rebound
Of Honeywell's three operating segments, it was, arguably, performance and materials technology that fared the worst in the second quarter. Reporting a 3% decrease in revenue -- a 4% decrease in core organic sales -- the segment also reported that profit fell 4% and segment margin dropped 20 bps. But management is reassuring investors that this will begin to improve in the third quarter.
Although management is forecasting the segment margin -- excluding mergers and acquisitions -- to fall between 100 bps and 120 bps, it's suggesting there will be a bright spot: Sales are expected to grow between 2% and 4%.
Investors should not only check to see if the segment meets its guidance, but look for commentary on the UOP business (formerly Universal Oil Products), specifically the backlog. In the second quarter, Honeywell reported a 10% increase, year over year, in the UOP backlog; further growth here would be an auspicious sign that the company is successfully navigating a challenging oil and gas market. During the Q2 conference call, management suggested that based on its growing UOP backlog, it "expect[s] the catalyst sales growth rates to improve in the second half of the year, particularly in the fourth quarter."
The takeaway
Honeywell recently provided revised guidance on fiscal year 2016, estimating that EPS will fall between $6.60 and $6.64 -- lower than the previous estimate of $6.60 to $6.70. Management provided some investors with a pre-Halloween fright in offering its picture of 2017. Let's see if the company's third-quarter performance is an early Halloween treat.
