Another year, another good performance from Honeywell International (NYSE:HON). But as ever, investors will focus on the outlook for 2019. The company accelerated organic sales growth to 6% in 2018 from 4% in 2017, and guidance for 2019 is calling for growth of 2% to 5% and for EPS to increase 6% to 10% on an adjusted basis. Is it enough to make the stock a buy, and what are the risks associated with the guidance? Let's try to answer these questions.

Honeywell's valuation

Looking at Honeywell's guidance quantitatively, the midpoint of the EPS guidance range of $7.80 to $8.10 puts the stock on a forward P/E of 18.2 times earnings. And the midpoint of guidance for free cash flow gives a forward price-to-FCF ratio of 18.8 times FCF -- or a FCF yield of 5.3%, if you prefer looking at it that way. Either way, it's a favorable valuation and suggests that the stock is a decent value with upside potential at the top end of the guidance range.

Check out the latest Honeywell earnings call transcript.

A fortune teller with buy, sell or hold options showing.

Image source: Getty Images.

But Honeywell's valuation isn't cheap enough to make the stock a good value if the company only hits the bottom end of its guidance range. So the question turns to a qualitative assessment of its earnings guidance for 2019.

HON Price to Free Cash Flow (TTM) Chart

HON Price to Free Cash Flow (TTM) data by YCharts

How Honeywell International makes money

Starting by looking back at 2018, you can see below that the largest segment (Aerospace) and the smallest (Safety and Productivity Solutions) contributed the most to earnings growth in the year. And it's notable that management expects them to grow sales in mid-single digits in 2019.

Furthermore, Honeywell spun off Garrett Motion (NYSE:GTX) (automotive turbochargers) and Resideo Technologies (NYSE:REZI) (home products and security products distribution) from the Aerospace and Building Technologies segments, respectively. That reduced earnings growth in 2018, but will lead to margin expansion in 2019 as both businesses were lower margin than their respective segments' margin.

Honeywell International Segment

2019 Sales Growth Outlook

2018 Organic Sales Growth

2018 Segment Profit

Change in 2018

Aerospace

Mid-single digit

9%

$3.503 billion

$215 million

Honeywell Building Technologies (HBT)

Low single digit

3%

$1.608 billion

($42 million)

Performance Materials and Technologies (PMT)

Low single digit

2%

$2.328 billion

$122 million

Safety and Productivity Solutions (SPS)

Mid-single digit

11%

$1.032 billion

$180 million

Data source: Honeywell International presentations.

Conservative guidance?

Digging into the assumptions behind Honeywell's guidance, CFO Gregory Lewis outlined that the low end of the 2% to 5% organic sales growth guidance "reflects the possibility of some economic slowing, but not a recession in 2019." However, he went on to argue that, "Based on what we can see today, we expect to be at the upper end of our sales guidance range for organic growth."

In a nutshell, management's conservative-looking guidance (in the table above, note how much Aerospace and SPS growth is expected to slow in 2019 versus 2018) is reflective of what Lewis called the "many uncertainties" in the economy and the fact that short-cycle businesses contribute around 60% of Honeywell's revenue. In other words, Honeywell will have limited visibility into the majority of its sales, and they can turn down pretty sharply in an economic slowdown -- hence the wide range in the guidance.

The Aerospace and Honeywell Building Technologies segments

That said, CEO Darius Adamczyk's commentary on current end-market conditions sounded pretty positive. Starting with aerospace, compared with United Technologies or GE, Honeywell has relatively high exposure to the highly cyclical business-jet market, but Adamczyk declared himself "very confident about our Aero outlook for 2019" and said it wasn't an area he would be losing sleep over.

HBT is probably Honeywell's problem-child segment. And now that the homes-focused Resideo business has been spun off, it's possible that management can do something about anemic growth in HBT's buildings businesses -- which were flat in the fourth quarter and the full year. Lewis expects some new products to help growth. And post-Resideo, this is an area that investors should expect some improvement in.

The Safety and Productivity Solutions, and Performance Materials and Technologies segments

After achieving 15% organic growth in the fourth quarter and 11% for the full year, guidance for the SPS segment looks conservative. In fact, Lewis and Adamczyk acknowledged that the majority of SPS consists of short-cycle businesses and therefore management is "trying to be a bit cautious" with guidance, according to Lewis. Nevertheless, given that Productivity Solutions' organic growth was 16% in 2018 and warehouse automation has strong growth prospects, it's reasonable to think there is upside potential to guidance if the economy holds up. 

Finally, the PMT segment saw some weakness in advanced materials in the fourth quarter (down 3% organically) due to softness in electronics, and the UOP business (catalysts and absorbents for refining) faces uncertainty due to the decline in oil prices. On the other hand, Rockwell Automation recently reported a good quarter while maintaining guidance and growth expectations for capital spending in heavy industries, which bodes well for Honeywell Process Solutions.

Is Honeywell a good value?

All told, Honeywell's guidance looks a bit conservative, so don't be surprised if management raises it through 2019. However, investors will probably need to see that, in order for the stock to significantly appreciate this year. On balance, Honeywell is a good value, but keep an eye on oil prices (for the PMT segment) and the business-jet market (for Aerospace), and expect some improvement in the HBT segment.