Better Buy: GE vs. Honeywell

Once upon a time, General Electric (GE -2.11%) and Honeywell (HON -0.70%) were meant to be merger partners. The deal was intended to be the last significant corporate action by GE's former CEO, Jack Welch, but it fell apart in 2001 due to competition concerns in Europe. Honeywell investors have reason to be glad; after all, their stock is up 540% since then, while GE stock is down a whopping 76%. However, the good news is stock prices have no memory. With this in mind, it's time to look into which stock is the better investment right now.

Honeywell International

If you are buying stocks purely based on the company's quality, then there is only one winner here. Simply put, Honeywell is one of the highest quality companies in the stock market today, let alone the industrial sector.

Honeywell is the very definition of a diversified industrial that makes money from a range of industries, and it has a management team committed to creating innovative investments aimed at generating "breakthrough products." In common with GE, Honeywell's aerospace operations have an opportunity to embark on a multi-year growth path as the commercial air travel market recovers. 

Honeywell and General Electric need commercial air travel to make a comeback. Image source: Getty Images.

Moreover, Honeywell has plenty of other growth opportunities in its other segments. Honeywell Building Technologies or HBT (building management systems, software, and hardware for complex buildings, fire, and security) has growth potential from the need to ensure buildings are healthy and clean in light of the pandemic. Moreover, Internet of Things (IoT) connectivity promises to enhance the productivity of HBT's solutions.

The safety and productivity solutions (SPS) segment is firing on all cylinders, driven by its warehouse automation (e-commerce logistics) solutions. Meanwhile, SPS's productivity solutions benefit from a red-hot market for mobile and barcode scanners that support automation and data capture in logistics and inventory management. Meanwhile, its sensing and IoT solutions are part and parcel of the trend toward automation and digitization.

Finally, the improvement in the price of oil should lead to a recovery in the performance materials and technologies, or PMT, oil-related sales (catalysts and absorbents to refiners, and process automation solutions). Meanwhile, advanced materials sales have already returned to year-over-year growth with the recovery in the industrial economy.  

Data source: Honeywell presentations. Chart by author.

General Electric

Honeywell's mix of its business and first-rate management team has ensured consistent earnings generation over the years. The chart below shows earnings before interest, taxation, depreciation, and amortization (EBITDA) for both companies. Honeywell's is far more consistent, and it's safe to bet that it will be the same in the future.

Data by YCharts

In contrast, GE has had significant issues in recent years. Its power segment has suffered as demand for gas turbines slumped due to the energy transition toward renewable energy. Meanwhile, burdened by unfavorable legacy contracts, GE's renewable energy business remained unprofitable and a cash user in 2020.

GE's aviation business slumped in 2020 due to the pandemic's impact on air travel, and the only segment to generate any significant free cash flow was healthcare.

Meanwhile, there are still question marks around GE's finance businesses, not least because of the billions worth of charges taken on them in recent years. 

Data source: General Electric presentations. FCF = free cash flow. 

Honeywell or General Electric?

At this point, readers might be surprised to know that I think GE is the better buy. The reasoning is that a lot of the good news is already in the price of Honeywell's stock. Moreover, under CEO Larry Culp, GE has a significant opportunity to improve profitability and cash flow.

GE Aviation's joint venture with Safran, CFM International, produces the LEAP engine (the sole option on the Boeing 737 MAX and one of the two options on the Airbus A320 NEO). It will benefit as the commercial aerospace market recovers. The GE Power segment is in turnaround mode, and its heavy-duty HA turbine continues to win orders. It's a similar turnaround story at GE Renewable Energy, where management establishes orders in offshore energy while working through unfavorable legacy contracts in onshore wind. Healthcare remains an area of strength.

Simply put, GE has the potential to improve its EBITDA more than Honeywell does in the next few years. That's something reflected in Wall Street analyst estimates. As you can see below, GE's enterprise value, or EV (market cap plus net debt)-to-EBITDA multiple, is forecast to drop below Honeywell's by the end of 2022.

As for GE's finance businesses, GE Capital is being transitioned into to GE Industrial, so GE's headline guidance for earnings and FCF now incorporates GE's finance businesses too. 

Data source: Marketscreener.com. Chart by author.

All told, if you prefer buying high-quality companies with reliable earnings, then Honeywell is a great option. On the other hand, GE's turnaround prospects are real, and the stock looks undervalued right now. As such, on a risk/reward basis, GE looks like the better option right now.