In line with most other industrial companies, Honeywell International (NASDAQ:HON) is facing some very difficult end markets in 2020. The company is definitely on the road to recovery, but it faces a long and rocky path ahead, and investors will need to be patient before they see significant improvement. Let's take a look at what we can expect and whether the stock is a good value in light of the recent earnings report.
The impact of the COVID-19 economy on the industrial stock can best be seen in the company's growth by segment. The chart below highlights the deterioration in the aerospace segment last quarter. A slump in commercial air travel and commercial airplane production caused a year-over-year organic sales decline of 27% for the segment.
Moreover, management expects the segment's sales to be down more than 25% in the third quarter.
CEO Darius Adamczyk discussed the aerospace market on the recent earnings call and outlined his view that "it's probably not going to get back to the 2019 levels until at least 2022 or maybe even a bit later." That's a somewhat more optimistic forecast compared to Raytheon Technologies' CEO Greg Hayes, who expects the recovery to take a year or two longer. Whichever way you look at it, it's going to take time for the aerospace segment to return to its former glory.
Honeywell building technologies
The outlook for the Honeywell building technologies (HBT) segment is somewhat complicated. Organic sales declined 17% in the second quarter, and management expects sales to fall by more than 10% in the third quarter.
On the one hand, Adamczyk is aiming to win future business by offering solutions that help make buildings healthier. On the other hand, sales will continue to be pressured by customer sites remaining closed. Additionally, customers are deferring nonessential spending on buildings, according to CFO Greg Lewis on the earnings call. All told, the HBT segment is another story of near-term pressure and long-term recovery.
Performance materials and technologies
The PMT segment is being hit from all sides. In advanced materials, lower automotive production hit its refrigerant sales, and lower oil prices are negatively impacting spending plans in process automation.
In addition, a combination of the slump in energy prices and a decline in automotive miles driven caused a 25% decline in sales at UOP (refining catalysts and absorbents). Total PMT sales declined 19% in the second quarter (17% on an organic basis), and management is calling for a decline of more than 10% in the third quarter.
Safety and productivity solutions
Clearly the star of the show at present, the SPS segment's organic sales rose 1% in the second quarter, and management expects an increase of up to 7% in the third quarter. The strength is in personal protective equipment sales and in Honeywell's warehouse automation business, Intelligrated.
In fact, Intelligrated orders were up a whopping 300% in the quarter on the back of ongoing strength in spending on e-commerce fulfillment centers. That said, the SPS segment is seeing weakness in sensing and Internet of Things spending as factories remain closed or operate at partial capacity.
What it means for investors
Putting it all together, it's clear that Honeywell has heavy exposure to a number of markets that are likely to recover slowly. It's definitely not going to be a quick turnaround for the company, and investors will need to be patient.
That said, there's still a lot to like about Honeywell:
- Management is planning $1.4 billion to $1.6 billion in cost cuts, with 60% to 70% of the cuts expected to be permanent. For reference, operating profit in 2019 was $7.7 billion, so the cost cuts are significant.
- Honeywell has a very strong balance sheet, with a current net debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple of less than 1 and $15.1 billion in cash and short-term investments.
- Honeywell trades at around 19 times Wall Street analyst expectations for free cash flow in 2021, a valuation in line with its traditional range.
With automotive production coming back from the COVID-19 shutdowns, oil prices stabilizing, and air travel slowly recovering, it's more a question of "when, not if" for a rebound in Honeywell's end demand. Throw in the possibility of some acquisition activity, structural cost cuts, a reasonable valuation, and a 2.4% dividend yield, and Honeywell starts to look like an attractive stock.
All told, Honeywell stock should be capable of generating double-digit long-term returns for investors. Just don't expect earnings to turn around sharply in the near term.