Honeywell International (HON -0.54%) stock soared higher last week after reporting better-than-expected Q1 2023 earnings. The stock is hovering around the $200-per-share mark and is now down just 11% from its all-time high.
Despite the earnings beat, Honeywell has a long way to go if it wants to return to meaningful growth. Here's where the giant conglomerate stands today, where it could be headed, and why the stock is a good buy now.
Image source: Getty Images.
Regaining its footing
The pandemic set Honeywell back by taking a sledgehammer to its profitability and margins. The company's largest segment -- aerospace -- was particularly impacted by an unprecedented slowdown in commercial air travel. Fast forward to today, and aerospace is once again Honeywell's fastest-growing segment.
Despite gradual improvements in 2021 and 2022, the company struggled to sustain top- and bottom-line growth across its business segments. In fact, 2022 marked a steep decline in revenue, profits, and free cash flow, with all three metrics down over the last five years.
HON Revenue (Annual) data by YCharts
The good news is that Honeywell could finally be turning the corner.
One of the main drivers behind its recent stock rally is that the company raised its guidance. Previous guidance called for 2023 sales of $36 billion to $37 billion, adjusted earnings per share of $8.80 to $9.20, and free cash flow of $3.9 billion to $4.3 billion. New guidance estimates revenue of $36.5 billion to $37.3 billion, adjusted earnings per share of $9.00 to $9.25, and no change in free cash flow.
Perhaps the most important green flag from Honeywell's report is that its profit margins and backlog are strong, which indicates pricing power and healthy demand. Honeywell recorded a 19.1% operating margin in Q1 2023, which was one of the highest quarterly operating margins the company has achieved in the last five years.
Focusing on fundamentals
If Honeywell hits its earnings target, it will have a forward price-to-earnings ratio of around 22, which isn't cheap. But it's also not terribly overpriced for an industry-leading business with a rock-solid balance sheet, rising dividend, and a multi-decade runway of earnings potential.
For years, Honeywell has sustained a very low financial debt-to-equity ratio because it isn't relying on debt to run its business.
HON Financial Debt to Equity (Quarterly) data by YCharts
Even during Honeywell's recent rocky period, the company has done a good job protecting its balance sheet by limiting the use of debt. Granted, the net debt position is up a little. But compared to industrial competitors of Honeywell's size, its balance sheet remains incredibly solid.
Companies that can persevere through challenging times without a deterioration in their financial health or a cut to their dividend build the trust needed for investors to hold their stocks over a long time horizon.
Speaking of dividends, Honeywell has also been steadily raising its payout. On April 24, it announced a $1.03 per share quarterly dividend payable on June 2. Five years ago, Honeywell's quarterly dividend was $0.7133 per share. 10 years ago, it was just $0.3546 per share. Even with all of these dividend raises, Honeywell only has a dividend yield of 2.1% because its stock price has outpaced the dividend growth rate.
In sum, Honeywell deserves a premium valuation because its margins have improved, its balance sheet remains in excellent shape, and it continues to raise its dividend.
Looking to a bright future
There are plenty of blue-chip dividend stocks that sport characteristics similar to Honeywell's. But few companies combine fundamentals with sizable growth potential.
Honeywell has spent years investing in the industrial internet of things, automation, artificial intelligence, and machine learning across its aerospace, building technologies, performance materials and technologies, and safety and productivity solutions divisions. It's complicated stuff, but the goal is essentially to harness data by connecting physical assets with the digital world.
One of the easier-to-understand examples is Honeywell Smart Energy. Instead of having several independently functioning elements of a utility system, Honeywell makes devices and software, and provides services to connect gas, water, and electric utility systems, which leads to better grid management and meter safety. It also helps utilities manage loads and can reduce cyber security risks as well.
Honeywell Smart Energy is just one of the many ways that Honeywell is preparing for the next stage of industrial innovation.
A compelling buy now
Investing is all about finding a business that can return value to shareholders for years to come -- whether that's through stock buybacks, dividends, or capital gains. Honeywell is a high-quality company that can return value to shareholders in a variety of ways. Its long-term investments chart a path toward earnings growth that can support future buybacks and dividend raises while also justifying a potentially higher stock price.
Honeywell may not have the highest dividend yield or do as many buybacks as other companies. But it does do a great job of pulling different levers to ensure it is allocating capital efficiently in a way that rewards shareholders in the short-term and the long term. All told, Honeywell is a well-rounded business that could be a great fit for a variety of investors.
