A strong set of earnings from Honeywell International (HON +1.62%) led to a mid-single-digit gain in the stock price, and it stands out in comparison with the difficulties at other industrials like General Electric Company (GE +0.42%). Does this stock price surge make for an opportunity for Honeywell investors to exit the stock or should they be buying more? I happen to think the answer is the latter, and here's why.
Honeywell Aerospace is a significant content provider on the F-16 Fighting Falcon. Image source: Getty Images.
Good earnings momentum
Honeywell has acquired an enviable reputation for being conservative with guidance and the second-quarter saw management raising guidance again. Under-promising and over-delivering are definitely preferable to GE's unfortunate reputation for failing to meet its earnings estimates in recent years, and the trend in Honeywell's full-year guidance in 2018 suggests the company has strong earnings momentum.
As you can see below, sales, EPS and free cash flow (FCF) guidance have been raised in the last two quarters. (Figures in bold represent guidance increases).
| Honeywell Full Year 2018 Guidance |
At Q4 17 |
At Q1 18 |
At Q2 18 |
|---|---|---|---|
|
Organic Sales Growth |
2%-4% |
3%-5% |
5%-6% |
|
Segment Margin |
19.3%-19.6% |
19.3%-19.6% |
19.4%-19.6% |
|
EPS |
$7.75-$8 |
$7.85-$8.05 |
$8.05-$8.15 |
|
Free Cash Flow |
$5.2-$5.9 billion |
$5.3-$5.9 billion |
$5.6-$6.2 billion |
Data source: Honeywell International presentations.
Valuation is attractive
It's worth noting that the midpoint of Honeywell's FCF full-year guidance has increased from $5.35 billion at the start of the year to $5.9 billion. It's a figure comparable to GE's current FCF forecast of $6 billion, the difference is GE started the year forecasting $6 billion-$7 billion.
On a price to FCF basis, Honeywell's guidance makes the stock look very attractive. Based on the current stock price of around $154, Honeywell's market cap is around $114.8 billion which means it trades on (using the midpoint of 2018 guidance) a forward price to FCF ratio of 19.5 times. That's a good value compared to recent years, and considering Honeywell's double-digit growth prospects it's a compelling valuation.
HON Price to Free Cash Flow (TTM) data by YCharts
Moreover, Honeywell is coming out of a period of heavy investment which held back FCF generation, but CEO Darius Adamczyk believes it will be able to increase its free cash flow generation. " We committed to be in the 90s this year. I feel even more confident of us being there. And I continue to be bullish about us making progress in '19 and beyond." In case you are wondering, the "90s" refers to 90% conversion of net income to FCF -- Honeywell is aiming to get this figure above 100% for the 2018-2022 period.
By their fruits, you will know them
Adamczyk highlighted some of the companies winning technologies during the earnings call. What's particularly interesting is that the heavy investments referred to above are really starting to come to fruition, and Honeywell is well placed in several high growth industries.
Of particular note, are initiatives such as connected aircraft including in-flight passenger Wi-Fi. Meanwhile, Honeywell Intelligrated (safety and productivity solutions segment) "provided the material handling of equipment design, installation, and support for Amazon's new more than 500,000 square foot distribution center north of Calgary" according to Adamczyk.
Moreover, Honeywell expects a large part of its growth in the future will come from its so-called breakthrough initiatives, the benefit being that Honeywell generated these products and therefore should have a strong competitive position for years to come.
All about aviation
Digging deeper into the reasons behind the continual guidance hikes, aerospace is the standout performer. For example, the midpoint of the full-year organic sales growth guidance has gone from 2% to 7.5% from the start of the year until now.
|
Full-Year Organic Growth Guidance |
At Q4 17 |
At Q1 18 |
At Q2 18 |
|---|---|---|---|
|
Aerospace |
1%-3% |
3%-5% |
7%-8% |
|
Home and Building Technologies |
1%-3% |
1%-3% |
2%-3% |
|
Performance, Materials and Technologies |
3%-5% |
3%-5% |
3%-5% |
|
Safety and Productivity Solutions |
4%-6% |
4%-6% |
7%-8% |
Data source: Honeywell International presentations. Figures in bold represent increases.
As you can see above, all ongoing businesses in the aerospace segment are firing on all cylinders, with a particularly welcome improvement in defense spending -- Adamczyk pointed out that it's "very clear" that a lot of NATO countries are increasing their defense budgets. With President Trump consistent in applying pressure on this issue, it's possible that the trend could continue in Honeywell's favor.
Elsewhere in the segment, the business aviation market continues to make a cyclical recovery and commercial aviation original equipment dollar sales are recovering nicely from the incentives granted in previous years in order to get on some new aircraft programs.
Data source: Honeywell International presentations. Chart by author
Is the stock a buy?
The valuation is attractive and Honeywell has plenty of good long-term earnings drivers and a world-class management team in place. Meanwhile, the intended spin-offs of the Transportation Systems and Homes businesses will increase focus on the fastest growing areas of the company.
Any kind of cyclical slowdown in the economy and/or escalation in trade conflict will obviously hit a stock like Honeywell, but if the global economy continues its growth path then Honeywell deserves a place in an investment portfolio.
