It was all so different a month ago. Honeywell International (NASDAQ:HON) reported a good set of fourth-quarter 2019 earnings on the last day of January, and its full-year 2020 guidance for 0%-3% organic revenue growth and 5%-10% EPS growth implied the company's growth rate would pick up though the year. Fast forward to the end of March and, at the time of writing, the stock is down 36% on a year-to-date basis upon fears that the COVID-19 pandemic will severely affect its earnings. What's going on, and is it time to bail out or buy the stock?
The remarkable thing about Honeywell's change in fortune comes from how quickly it's all happened. Let's focus on aerospace for the moment, as it's Honeywell's biggest earnings generator.
In a company webcast on March 5, Honeywell Aerospace chief executive officer Mike Madsen was asked about the coronavirus effect, and he said it was a "a phenomenon here that affects about 15% of our business." It's an argument based on the idea that only "25% of our business is tied to the repair and overhaul cycle" where "a little more than half is pegged to the air transport space." On March 10, chief financial officer Greg Lewis affirmed the company's overall first-quarter guidance with full-year guidance left unchanged.
However, matters have deteriorated since then. While it was clear in January that the aerospace industry would take a hit from reduced passenger traffic as a result of the novel coronavirus in Asia, it's fair to say that most observers weren't expecting the crisis to spread so quickly and deeply to the rest of the world.
Indeed, aviation analysts have been increasing their estimates for the negative effects on airline revenue almost on a weekly basis. For example, the International Air Transport Association (IATA) now believes the effect on airline revenue could be more than $113 billion, compared to an estimate of $29.3 billion given in February.
Moreover, the financial distress many airlines are now under and the potential for consumer sentiment to remain negative on air travel, even after the COVID-19 pandemic is contained, mean Honeywell's original equipment manufacturer and provisioning revenue is also under threat now. It's not just a question of temporary weakness in repair and overhaul revenue anymore.
The threats extend beyond aerospace. For example, the safety and productivity solutions (SPS) business contains substantive so-called "short cycle" businesses such as industrial safety products and productivity products (barcode scanners, mobile computers, etc.) which will get hit when factories shut down.
Moreover, the crash in oil prices could hurt Honeywell UOP (catalysts and absorbents for refining) within the performance materials and technologies (PMT) segment. In addition, it's anyone's guess how the commercial construction industry (Honeywell Building Technologies, or HBT) will respond to an economic slowdown.
The market is pricing in the worst
Simply put, Honeywell's growth prospects are now challenged across its whole portfolio. However, a look at the stock's valuation suggests that the market has already been quick to price in the most pessimistic scenario. The chart below shows how Honeywell's current price to free cash flow and enterprise value (market cap plus net debt), or EV to earnings before interest, taxation, depreciation and amortization (EBITDA) multiples now stand at levels below what they were before the last recession.
Of course, the bearish scenario is that commercial aviation will experience a protracted slowdown -- even in the event of a containment of the COVID-19 outbreak -- and the economy at large will dip into a substantive recession. In that case, the market may well be right to have sold off Honeywell's stock so aggressively.
Alternatively, the most bullish case sees COVID-19 as being contained in due course, just as it's largely been in China, with economic activity and air travel returning to normal over time -- as it did after the SARS outbreak in 2002-2003.
The answer probably lies somewhere in the middle of these two scenarios, but given that the market appears to have priced in a 2008-2009 style recession into Honeywell's stock price, the stock looks like a good value on a risk/reward basis for long-term investors looking for an entry point.