It's been a good year so far for Honeywell International (HON 0.38%). The stock is up nearly 24% year to date, and management has raised the bottom end of its full-year earnings guidance range in the first two earnings reports.
In order to judge whether its good run can continue, let's preview the key things to look out for from each segment when Honeywell reports its third-quarter earnings on Oct. 20.
Latest guidance
Here are management's expectations for the third quarter given at the time of the second-quarter earnings. The headline guidance has proven too conservative already: management recently gave a preview of its anticipated earnings and announced reported sales would grow 3% with organic sales up 5%, both notably ahead of original guidance.
|
Third-Quarter Guidance |
Reported Sales Growth |
Organic Sales Growth |
Segment Margin |
|---|---|---|---|
|
Aerospace |
(4%) to (2%) |
Flat to 22% |
2.9% to 3.3% |
|
HBT |
Flat to 2% |
1% to 3% |
0.1% to 0.4% |
|
PMT |
(8%) to (6%) |
7% to 9% |
1.3% to 1.7% |
|
SPS |
19% to 21% |
2% to 4% |
0.4% to 0.7% |
|
Total |
(1%) to 1% |
2% to 4% |
1.2% to 1.6% |
Data source: Honeywell International presentations.
Home & building technologies
Both HBT and safety & productivity solutions (SPS) segments reported good sales growth in the second-quarter, though margin came in weaker than expected. But investors wondered whether sales would continue to expand handsomely and help offset any lingering margin challenge.
Starting with HBT, CFO Tom Szlosek cited an unfavorable sales mix in the quarter, with "higher sales of lower margin products in smart energy and environmental and energy solutions and lower volumes in security and fire." Essentially, management's efforts at cutting costs in smart energy solutions haven't "materialized as quickly" as expected. Furthermore, the strong sales performance -- organic sales came in at the top of the 2%-4% guidance range in the second-quarter -- was helped by 20% growth in China. This creates a margin issue, because the HBT solutions popular in the China market tend to be lower-margin.
Ultimately, if China's economic growth slows in the third quarter, then HBT sales growth could slow and fail to offset any lingering margin weakness. In addition, look out for commentary on cost-cutting measures in Honeywell's smart energy solutions. Margin matters for HBT.
Honeywell International provides premium inflight entertainment products. Image source: Getty Images
Safety & productivity solutions
Turning to SPS, the margin shortfall in the second quarter was caused by productivity solutions, particularly mobility solutions in North America. In a nutshell, Honeywell will launch new products in the second half, but the "more aggressive" launches won't occur until the fourth quarter. This is causing problems for two reasons. First, productivity products sales decreased in the second quarter, with customers possibly waiting for the new products. Second, new product launches require investments.
All told, investors should look out for productivity products sales guidance. But on a more positive note, the recently-acquired Intelligrated automated material handling solutions business is expected to report double-digit sales growth. The key to the SPS segment is sales growth.
Aerospace
As you can see in the table above, Honeywell is expecting moderate sales growth, accompanied by significant margin expansion in the quarter. Management's expectations were laid out on the second-quarter earnings call:
- Strong air transport deliveries for new platforms in commercial original equipment (OE).
- Modest growth in business aviation aftermarket.
- Strong growth in aviation aftermarket overall.
- Margin expansion from tailwinds caused by heavy customer incentives granted in last year's third quarter.
Frankly, it wouldn't be surprising if aftermarket sales were strong. As you can see below, they grew at 5% in the last couple of quarters. Industry peer United Technologies (RTX -0.04%) has also reported a trend of strong aftermarket sales but weaker-than-expected OE sales.
Data source: Honeywell International presentations. Chart by the author.
The question is whether these trends can continue. Aftermarket sales can bounce around, but they are driven by miles flown -- and Honeywell and United Technologies management will have a good line of sight on this metric. However, it's arguably harder to predict where OE sales will go, which makes it something to look out for, particularly as the incentives were granted precisely to drive OE sales growth.
Performance Materials and Technologies
PMT's strong performance in the second quarter was a welcome return to form after a disappointing 2016 that saw PMT segment sales guidance cut as the year progressed. The reason for the difficulties in 2016? Simply put, UOP subsidiary (catalysts and absorbents for the processing industry) sales growth disappointed due to weaker-than-expected energy-related capital spending. Fast forward to 2017, and the stabilization in oil prices has led to a bounce in demand. Management expects UOP to deliver more than 20% growth in the third quarter.
While this was somewhat easy for management to predict due to a growing backlog, investors should keep an eye out for commentary on UOP orders to see whether the recovery in energy-related capital spending is sustainable.
Looking ahead
All told, each segment has a mix of positives and negatives to look out for, and to be fair a company of Honeywell's size and diversity is never going to firing on all cylinders at all times. However, the recent pre-announcement for the third quarter saw management calling out aerospace and PMT as performing strongly. In addition, while sales are forecast to be ahead of the guidance given for the second quarter (see first table above), the guidance for EPS of $1.75 is only at the top end of the $1.70-$1.75 range.
These two facts suggest there has been some more margin difficulty at HBT and SPS, and that's what investors need to focus on the most in the upcoming earnings presentation.
