Honeywell's (HON 3.14%) second-quarter earnings were good, and management actually raised its full-year revenue, earnings, and cash flow guidance, so no complaints there. However, some soft spots are appearing, and the relatively cautious guidance appears to be justified. It looks as if Honeywell is going to have to continue its track record of excellent execution in order to generate any more upside out of 2019. Let's take a look at the earnings and what they mean for some of the company's peers.
Another quarter of execution
Organic revenue growth of 5% in the quarter came in toward the low end of the 4%-to-7% guidance range, but margin expanded more than expected, leading to EPS of $2.10 -- right at the top of the guidance range of $2.05 to $2.10. Moreover, as you can see below, full-year guidance was raised across the board. For reference, the new EPS guidance implies growth of 8% to 10% if you adjust for the spin-offs of Resideo and Garrett Motion.
|
Full-Year 2019 Guidance |
At Q2 19 |
At Q1 19 |
At Q4 18 |
|---|---|---|---|
|
Organic sales growth |
4% to 6% |
3% to 6% |
2% to 5% |
|
Segment margin |
20.7% to 21% |
20.7% to 21% |
20.7% to 21% |
|
Earnings per share |
$7.95 to $8.15 |
$7.90 to $8.15 |
$7.80 to $8.10 |
|
Free cash flow ($billions) |
$5.7 to $6.0 |
$5.5 to $6.0 |
$5.4 to $6.0 |
Data source: Honeywell International presentations.
That said, the guidance for the third quarter implies a clear slowing of growth, and there were some disappointments on a segmental level in the quarter. The chart below shows that the midpoint of guidance for the third quarter implies the lowest growth figure for two years, and it should be noted that Honeywell's five-year plans call for 3% to 5% annual growth.
Data source: Honeywell International presentations.
The good from the quarter
To understand what's going on, you have to get into the segment detail. It's a story of one continual outperformer (aerospace), two surprisingly good ones (home and building technologies, or HBT, and performance materials and technologies, or PMT), and one disappointing one (safety and productivity solutions, or SPS).
In a result that bodes well for the upcoming earnings of General Electric and United Technologies, Honeywell's aerospace segment had its fourth straight quarter of double-digit growth, with ongoing strength in the aftermarket. In addition, regarding defense and space, CEO Darius Adamczyk told Vertical Research Partners' Jeff Sprague that through the "end of 2020, we have more than 50% of the business already booked."https://www.fool.com/premium/coverage/earnings/call-transcripts/2019/07/18/honeywell-international-inc-hon-q2-2019-earnings-c.aspx
Data source: Honeywell presentations.
PMT's organic revenue growth of 4% follows 5% in the first quarter. It's an impressive result considering that process solutions rival Emerson Electric management has been talking about orders being pushed out in 2019. Adamczyk was asked about the matter, and he said some of the larger projects were possibly "sliding a little bit to the right."
However, the overall bookings and backlog at PMT led CFO Greg Lewis to say regarding the PMT growth outlook in the second half, "With the backlogs that we have entering the back half of the year, we think mid-single-digits is a very reasonable spot for PMT." Moreover, the second-largest part of PMT, namely UOP (catalysts and absorbents for refining and petrochemicals), grew orders and backlog by more than 10% in the quarter, according to Lewis.
Honeywell's space and defense sales are surging. Image source: Honeywell website.
The third strongly performing segment, HBT, saw 5% organic revenue growth following 9% in the first quarter -- a somewhat surprising performance from a part of Honeywell that's long been a laggard. However, the separation of Resideo seems to have enabled significant improvement at HBT, and Lewis outlined that building solutions backlog had grown in double digits, positioning "the business well for the second half of 2019."
While aerospace's growth looks assured, the question is whether Honeywell could see some weakness in the cyclical HBT segment in the future, and it will be interesting to hear what Emerson Electric says about its process automation orders too.
The bad
Turning to the disappointment at SPS, it's here that the cyclical slowdown is being felt the most. Industrial safety (around 32% of segment revenue) product sales was the one blemish in the first quarter, and the weakness continued in the second.
However, productivity solutions got hit by a double whammy of notable weakness in productivity products (22% of SPS segment sales) -- an area where Honeywell competes directly with Zebra Technologies -- and what Adamczyk described as a "blip" in large project order bookings in warehouse automation (27% of SPS segment sales).
While productivity products are expected to remain weak in the near future -- it's not clear if Zebra is taking market share or the market is slowing -- Adamczyk remains bullish on warehouse automation, and an improvement in orders is expected at least by the fourth quarter.
Data source: Honeywell International presentations. Chart by author.
What it means to investors
This is a good set of results and positive guidance, and Honeywell continues to execute very well. But if the economy weakens, HBT and process solutions (PMT) orders could come under pressure. Meanwhile, SPS is set for another negative quarter of growth, and investors will be eagerly waiting for an improvement in warehouse automation orders.
All told, given the relatively high valuation -- the high end of EPS guidance puts Honeywell on a forward PE ratio of more than 21 times earnings -- it wouldn't be surprising to see the stock tread water while waiting to see how the global economy pans out in the second half of the year.
