Please ensure Javascript is enabled for purposes of website accessibility

Better Buy: GE vs. Honeywell

By Lee Samaha – Jun 19, 2020 at 8:58AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Comparing the investment propositions for the two industrial giants.

It hasn't been a great year for investors in General Electric (GE -1.24%) or Honeywell International (HON -1.08%). The COVID-19 pandemic and the associated travel bans have caused a severe slump in the commercial aviation sector and that's bad news for businesses that have commercial aviation as their biggest single profit generator.

But investing in stocks is more about what will happen in the future, so let's take a look at which one of these industrial giants might be a better value right now.

General Electric and Honeywell valuations

Industrial conglomerates are traditionally valued on the basis of an earnings or free cash flow (FCF) multiple. The idea is that they should be diversified enough to generate earnings/FCF throughout an economic cycle, give or take some adjustment for the state of the economy. As a rough benchmark, a figure of 20 times FCF is probably a fair value for an industrial conglomerate. FCF is simply what's left over from operating cash after capital spending.

A pair of scales with two bags labeled risk and reward.

Image source: Getty Images.

To put this into context, an FCF of 20 implies the company is generating 5% of its market cap in FCF. Theoretically, that FCF can be used to pay a dividend, make stock buybacks, or help fund acquisitions to boost growth. A quick look at GE and Honeywell on a trailing-price-to-FCF basis makes the decision look like a no-brainer (see chart below).

Moreover, the slump in the economy in 2020 means that GE's management believes its FCF will be negative for the full-year, while analysts have Honeywell generating around $4.7 billion, putting it on a 2020 price-to-FCF multiple of 21.1 times. Again, Honeywell looks like the clear winner.

GE Price to Free Cash Flow Chart

Data by YCharts

Long-term value for GE

GE bulls will argue three points:

  • The company is in the middle of a multi-year turnaround (particularly in its power and renewable energy segments), so its current FCF isn't reflective of its long-term potential.
  • Commercial aviation (more important to GE than it is to Honeywell) has obviously taken a major hit in 2020, so this year's FCF projection is also not representing the long-term potential.
  • The nature of GE Aviation (around three-quarters of revenue comes from commercial engines and services) means that one-year-out FCF is not the best way to measure the business.

To add some color to the third point, consider that aircraft engines tend to be sold at a loss in order to generate lucrative aftermarket and service revenue a few years after they start to need to be serviced.

To build these points into a comparison, let's take a look at a snapshot of what the investment proposition for GE could look like in 2022. By then the power and renewable energy segments should be cash generative and in growth mode, and aviation should have recovered. Based on analyst FCF estimates, and the current market cap, GE will trade at 18 times FCF in 2022.

General Electric

2019 Free Cash Flow 

2022 and Beyond

Power

($1.5 billion)

GE Power will get back to high-single-digit earnings/FCF margin with $1 billion in FCF and low-single-digit growth in the future

Aviation

$4.4 billion

GE Aviation will recover in line with commercial aviation recovery, and long-term FCF will be generated from engine spares sales

Renewable energy

($1 billion)

Margins will get back on track for high-single-digits in line with peers, and the bet on offshore energy will start to pay off

Healthcare*

$1.2 billion

Steady low- to mid-single-digit growth in earnings/FCF

Corporate & eliminations

($2.1 billion)

Cost cuts will lower outflows

Total GE industrial*

$1 billion

Analyst projections for $3.5 billion

Data source: GE presentations, marketscreener.com, author's analysis. *Excludes $1.3 billion from the biopharma business

Long-term value for Honeywell

In comparison, analysts are expecting Honeywell to be generating $6.1 billion in FCF in 2022, a figure slightly above that generated in 2019. It would put Honeywell on 16.6 times FCF in 2022, a figure notably lower than that projected for GE.

In addition, Honeywell has a far more diversified set of income streams than GE does. To illustrate this point, here's a look at Honeywell's segments by share of revenue in 2019. As you can see below, Honeywell actually generates nearly double the revenue from its defense and space segment compared to its commercial aviation original equipment market (OEM) -- the aftermarket is seen as recovering faster than OEM in aerospace. 

Honeywell's revenue share by business.

Data source: Honeywell presentations. UOP sells catalysts and absorbents to refining companies.

Honeywell certainly has businesses that are cyclically challenged in the near term -- overall sales are expected to decline more than 15% in the second quarter of 2020. However, it also has some strong long-term growth businesses such as warehouse automation (productivity solutions), defense, and space.

In addition, the company's process solutions, UOP (which sells catalysts and absorbents to refining companies), and advanced materials segments should recover in line with the economy. In addition, there's even an argument that building technologies segment sales will receive a boost in a post-COVID-19 world as building owners seek to create healthier buildings. 

Honeywell or General Electric?

On a risk/reward basis, there are two reasons why Honeywell is the better buy. First, on current, 2020, and 2020 projections, it trades on a lower FCF multiple than GE. Second, there's probably less risk in Honeywell meeting analyst expectations than there is with GE right now.

You can build a case for GE, but it relies on a multi-year turnaround in power and renewable energy -- including the success of its nascent offshore wind business -- and an ongoing recovery in commercial aviation.

Simply put, there are a lot more things that need to go right for GE than there are for Honeywell, and the latter's valuation is more compelling anyway. Honeywell is the better buy.

Lee Samaha owns shares of Honeywell International. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

General Electric Company Stock Quote
General Electric Company
GE
$64.55 (-1.24%) $0.81
Honeywell International Inc. Stock Quote
Honeywell International Inc.
HON
$171.38 (-1.08%) $-1.87

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.