Honeywell International (HON 0.22%) replaced Raytheon Technologies, now RTX Corporation, in the Dow Jones Industrial Average in 2020. Unlike Raytheon, which is more of a pure-play defense contractor, Honeywell is a diversified industrial with exposure to commercial aviation, building technologies, utilities, healthcare, oil and gas, consumer products, and a slew of other industries that traverse pretty much every sector of the economy.
However, Honeywell stock is down over the last two years and is down 8.9% year to date despite a 7% gain for the Dow. This begs the question, is Honeywell an underrated dividend stock that's worth a look, or is its underperformance justified?
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A unique Dow industrial stock
One of Honeywell's greatest differentiating factors among the Dow industrial stocks is its balance sheet. The company operates a highly efficient business and has limited the use of leverage. As a result, it has the lowest debt-to-capital and financial debt-to equity-ratios of the four industrial stocks in the Dow.
HON Debt To Capital (Quarterly) data by YCharts.
Honeywell's lack of leverage and diversified business makes it an attractive choice for risk-averse investors. The company has the wiggle room needed to make acquisitions when few companies are able to do so. Or it can tap into cash reserves if its free cash flow falls short of dividend obligations. It's a powerful position to be in, but Honeywell may be conservative to a fault.
How to flex financial muscles
Let's turn to integrated oil and gas major Chevron (CVX 0.37%) as an example of a Dow stock that has used its healthy balance sheet to its advantage in recent years.
After the oil and gas crash of 2015, Chevron slashed its spending and shored up its balance sheet. The conservative strategy came in clutch when oil and gas prices plunged in 2020. Chevron was not only able to ride out this storm and support its dividend when many of its peers were cutting their dividends, but it was also able to make an incredibly timely and sizable acquisition with the purchase of Noble Energy in 2020, followed by the acquisition of Renewable Energy Group in 2022 and the purchase of PDC Energy in 2023. Combined, the Noble Energy and PDC Energy acquisitions totaled over $20 billion and boosted Chevron's position in key onshore oil- and gas-producing regions. Meanwhile, the $3.15 billion purchase of Renewable Energy Group was mainly a play in biofuels.
Chevron is a good example of a company that used its healthy balance sheet to justify all-stock transactions and make timely strategic moves. In hindsight, this is the kind of decision-making investors may have wanted to see from Honeywell when asset prices were on the cheap.
As my colleague, Lee, pointed out, advanced composite technology company Hexcel (HXL -0.03%) was open to exploring strategic options during 2020. It would have been interesting if Honeywell went after a company like Cognex (CGNX 2.06%), a maker of machine vision products. Trimble (TRMB 1.59%) would make a lot of sense in Honeywell's Building Technologies segment. Not to say these companies were open to selling, but Honeywell had the balance sheet needed to pull off a transaction if it wanted to.
M&A just for the sake of boosting short-term returns is a losing move in the long run. And it's hard arguing against Honeywell's decision to play it safe. Rather, the message here is that it would be a shame if Honeywell passed on a juicy opportunity just because it was overly assessing about a few percentage points of profit margin.
What Honeywell has going for it
Despite its general inability to take action, Honeywell has delivered on its promises to investors. It has rebounded its business, returned to growth, and is on track to achieve a gradual margin expansion in lockstep with mid-single-digit organic growth. It's not a glamorous plan, but it's a plan that supports dividend raises and buybacks.
Honeywell stock may have a dividend yield of just 2%. But the company has maintained or raised its dividend every year for the last 30 years, including raising its dividend every year since 2012. The buybacks took an understandable pause during the COVID-19 pandemic but have still gradually increased and should remain sizable in the years to come.
In addition to a solid balance sheet, dividend raises, and a manageable buyback program, Honeywell has exposure to a lot of exciting trends. The company has developed a number of software-as-as-service solutions for industrial customers and has invested heavily in the Industrial Internet of Things (IIoT). IIoT is a way to improve asset performance and lower maintenance costs by digitally connecting assets and monitoring them virtually instead of having to conduct site visits all the time.
Although the industry features a multidecade growth runway, Honeywell's conservative capital spending and muted growth forecast indicate the company is investing in trends like IIoT in a way that is likely to lead to gradual growth while also not compromising short-term profit margins. This isn't necessarily a bad thing, but it does weaken the argument that Honeywell is a worthy growth play on IIoT, automation, and artificial intelligence.
Honeywell stock has potential
Honeywell is a balanced company and a reasonably priced stock. But the company's conservative growth projections put a limit on its valuation expansion. Honeywell remains a great passive income option. But it's hard to see the stock outperforming its peers, let alone the broader Dow Jones Industrial Average.
However, this is just the state of Honeywell now. The stock could become much more attractive if it makes effective acquisitions for a good price or if the stock simply reaches a less expensive valuation. If that were to happen, Honeywell would definitely be a sleeping giant. But until then, it's just a well-run diversified industrial stock with a low growth rate.
