Honeywell International's (HON 3.27%) first-quarter earnings were good, but perhaps they could have been a bit better. The timing of the recovery in its commercial aerospace and oil- and gas-focused end markets is a bit slower than many had hoped. That said, there's clear evidence of broad-based improvement, management raised its full-year guidance, and it looks likely that Honeywell will have significant momentum as it exits 2021. Here's why.
Honeywell beats and raises
The headline numbers, first-quarter sales, segment margin, and adjusted EPS came in ahead of management's guidance. Turning to the full-year guidance, management upgraded all of the metrics in its guidance except for its margin expansion -- a point we'll get back to shortly.
Honeywell needs the commercial aviation industry to come back strongly in 2021. Image source: Getty Images.
To be fair, the market was somewhat prepared for the good news as it's become clear that many of its end markets were improving.
| Metric | Actual Q1 2021 | Guidance For Q1 2021 | Updated Full-Year Guidance | Previous Full-Year Guidance |
|---|---|---|---|---|
| Sales | $8.5 billion |
$7.8 billion to $8.2 billion | $34 billion to $34.8 billion | $33.4 billion to $34.4 billion |
| Segment margin | 21% | 20.4% to 20.9% | 20.7% to 21.1% | 20.7% to 21.1% |
| Adjusted earnings per share | $1.92 | $1.68 to $1.83 | $7.75 to $8 | $7.60 to $8 |
| Free cash flow | $0.8 billion | N/A | $5.2 billion to $5.5 billion | $5.1 billion to $5.5 billion |
Data source: Honeywell.
Three disappointments
First, as noted above, Honeywell didn't raise its full-year margin guidance. This is somewhat surprising as management raised sales guidance, and there's usually some benefit to margin as sales increase due to the benefits of scaling up production. The segment margin guidance for the second quarter calls for a range of 19.8% to 20.3%, a figure below the first quarter's margin figure of 21%.
The reason? It comes down to the fact that more of Honeywell's sales growth is coming from lower-margin activities. CEO Darius Adamczyk outlined that its fastest-growing business was Intelligrated, a warehouse automation business that continues to report stellar growth due to e-commerce warehousing demand.
Intelligrated operates out of the safety and productivity solutions (SPS) segment. Given that the SPS segment margin is the lowest of the four segments, it's understandable that its growth is leading to margin pressure. For reference, the SPS margin was 14.3% in the first quarter compared to 29% for aerospace, 22.5% for Honeywell Building Technologies (HBT), and 18.5% for the performance materials and technologies segment.
Honeywell presentations. Chart by author. YOY = year over year.
Second, the aerospace segment performance and outlook were slightly disappointing. As expected, the business and general aviation (BGA) business is recovering fine, driven by a strong recovery in private & business jet flights. However, weakness in international flights means Honeywell is now trending toward the low end of its guidance for flat to low-single-digit organic sales growth for the segment in 2021.
Data source: Honeywell presentations. Chart by author.YOY = year over year.
Third, it's a similar story with the oil-related end markets in the PMT segment. Advanced materials sales are coming back strongly, driven by an improving industrial economy. However, UOP (absorbents and catalysts to the refining industry) sales continue to suffer due to weak conditions in energy end markets.
Honeywell Process Solutions (HPS) organic sales declined 9% due to "continued project delays and lower smart energy demand due to some softness in the end markets," according to CFO Greg Lewis. Because of this, management sees sales trending toward the low end of its full-year guidance range for a low-single-digit decline to a low-single-digit gain.
Data source: Honeywell presentations. Chart by author. YOY=year over year.
What it all means for investors
Putting the results and commentary into perspective, it looks likely that it's a case of when, not if, Honeywell will be firing on all cylinders by the end of the year. International and European domestic flights will surely follow the pattern of China and U.S. domestic flights and recover as vaccination programs roll out. That will be good news for Honeywell's higher-margin commercial aviation aftermarket sales.
Meanwhile, Lewis said UOP orders were up double-digits in the quarter, and Adamczyk believes that the HPS sales "typically trails UOP by two to four quarters." With early signs of a recovery in UOP sales in place, and the price of oil remaining at above $60 a barrel, the PMT segment should start to be in recovery mode by the end of the year.
All told, the HBT and SPS segments are "trending better than expected" and management raised overall sales and earnings guidance. Although the PMT and aerospace segments could have been better in the first quarter, both end markets are improving, and growth is likely to improve in the future.
