A quick look at the relative stock price performances of Honeywell International (NYSE:HON) and General Electric Company (NYSE:GE) in 2017 shows a nearly 40% outperformance by the former. How is this so? Both companies are diversified industrial conglomerates with many end markets in common, particularly aerospace, so their stock prices should be roughly correlated, right?
Well, clearly the charts suggest otherwise, so let's look at one aspect of what's gone wrong with GE this year, and what it can learn from Honeywell's management.
General Electric Company and Honeywell
The two companies share much in common, including two topical concerns: Both appointed new CEOs in 2017, and both disappointed investors in 2016 because of weakness in end markets.
Darius Adamczyk, an ex-GE employee, took over the reins at Honeywell in April, while John Flannery took over GE at the start of August. Superficially at least, they have taken over companies with similar recent histories.
GE started 2016 expecting revenue growth of 2%-4% only to report 1% at the end of the year. However, it wasn't all bad, as full-year EPS of $1.49 came in at the middle of initial guidance range of $1.45-$1.55. In a similar vein, Honeywell started 2016 expecting core organic sales growth of 1%-2%, only to report a decline of 1%. Meanwhile, Honeywell's full-year EPS of $6.60 also came in within its initial guidance range of $6.45-$6.70.
In a nutshell, both companies missed their initial revenue estimates and reported earnings in the middle of their initial guidance ranges. The reasons? For GE it was largely down to deteriorating capital spending in the oil and gas industry. Honeywell was hit by a combination of weaker spending in energy-related processing in its UOP (catalysts and absorbents for the processing industry) business and a slowdown in the business-jet and helicopter markets.
And it's here where the two companies diverge.
What Honeywell did
Simply put, at the end of 2016 Honeywell started issuing guidance that looked conservative, and GE didn't. Honeywell raised guidance in its first two earnings reports this year, and management appeared to deliberately downplay expectations.
For example, after a strong first quarter in a recovering industrial environment -- not least for UOP orders, which increased 15% -- Honeywell's management left each individual segment's sales and margin guidance untouched. The only concession came from nudging the full-year EPS guidance range upward by $0.05 at the bottom end to $6.90-$7.10 --management still expressed caution on its short-cycle businesses, even though the economy was clearly improving.
Fast-forward to the second quarter, and another strong set of results encouraged management to push the bottom end of full-year EPS guidance up by $0.10 to $7-$7.10, and the midpoint of full-year sales guidance from $39.05 billion to $39.65 billion. However, it still looks a bit conservative, especially given strong aerospace aftermarket sales and UOP orders.
What General Electric Company did
If Honeywell's story is one of under-promising and over-delivering, GE's certainly is not. To be fair, GE maintained its full-year 2017 guidance in its first- and second-quarter earnings -- organic revenue growth of 3%-5%, operating EPS of $1.60-$1.70, and industrial cash flow from operating activity (CFOA) of $12 billion to $14 billion. Moreover, former CEO Jeff Immelt still didn't abandon the target of $2 of industrial EPS in 2018.
But here's the thing.
- The latest results saw CFO Jeff Bornstein lower expectations to the bottom end of the cash flow and earnings guidance.
- Industrial CFOA missed estimates by $1 billion in the first quarter, and management has plenty of work to do.
- The oil and gas and power segments have disappointed in 2017, at least compared with expectations.
- Immelt appeared to back off the $2 target at an investor event earlier in the year.
Simply put, GE's guidance has arguably been too optimistic, and the analyst EPS consensus for 2017 is just $1.57, while for 2018 its $1.70 -- numbers that imply new CEO John Flannery could be forced into lowering guidance in the future.
Simply put, Honeywell has done a better job of managing investors' expectations than GE has, and Adamczyk's tenure has started on a far easier note than Flannery's has. No matter, as Flannery now has an opportunity to possibly reset investor expectations -- something the analyst consensus suggests he should do -- and the stock could start appreciating.
GE has earnings growth catalysts in the next few years , not least from significant structural and production costs, digital initiatives and acquisition integrations, but the potential good news needs to be viewed within a framework of guidance that the company can realistically hit. That's a lesson GE can learn from Honeywell.