Shares of Honeywell International (NYSE:HON) have been somewhat of a laggard over the past year. The stock has only moved higher by 11.5% in the past 12 months, compared to the S&P 500's gain of 17.5%. 2014 has been a similar story, with the stock only moving higher by 4%. But could shares of this diversified industrial company be poised to move higher?
Profits will climb in the back half of 2014
Since reporting second-quarter earnings on July 18, the share price is flat. That's surprising, given that Honeywell beat on top- and bottom-line earnings expectations, increased cash flows, and raised full-year guidance.
But the guidance is what got me curious. The company raised the bottom end of its full-year EPS guidance to the range of $5.45 to $5.55 from the previous range of $5.40 to $5.55. Not much, but still, better than before. Even more recently, the company raised revenue guidance for its upcoming third quarter.
So, even after a stellar quarter and raising guidance, the stock doesn't deserve some love? That would make sense if it was egregiously overpriced. But considering it trades in line with the S&P 500's trailing-12-month price-to-earnings ratio of 18.7 and below the industry's average P/E ratio of 19.6, I wouldn't exactly say Honeywell is expensive. So, valuation and higher profits are certainly reasons for the stock to go higher.
What's driving profits?
Of course, it's hard for a company to guide earnings higher without having a business, or several businesses, that are doing better. For one, higher margins are a key driver to boosting profits.
One way that will be helped is from the company's planned merger of two business segments: aerospace and transportation systems.
This newly combined segment will begin being report in the third quarter, and the synergies will allow for further margin gains, according to management.
Each one of Honeywell's business segments -- aerospace, transportation systems, performance material and technologies, and automation and control solutions -- saw margins climb in the most recent quarter. According to the company's presentation, management also expects this trend to continue, which will ultimately boost profits.
Aerospace should continue to drive revenues
In the most recent quarter, sales were flat for Honeywell's aerospace division. But I don't expect that to last because of the sheer size of other jet-producing companies' backlogs.
For instance, in its most recent quarter, Boeing (NYSE:BA) -- one of Honeywell's customers -- had a backlog of $377 billion, good for 5,200 planes and seven years worth of production. Boeing also raised guidance in the most recent quarter, suggesting that management's outlook remains bright.
Bombardier (NASDAQOTH:BDRBF) and Airbus (NASDAQOTH:EADSY) also have sizable backlogs and are also customers of Honeywell. Bombardier, according to its latest report, had a backlog of about $76 billion, which should provide five years of solid revenue growth, according to management.
Airbus has a current backlog of almost 6,000 planes and what the company estimates to be "eight to nine years of output at full production rates."
Look for Honeywell to not only have a steady stream of growing revenues in aerospace, (which many investors have expected), but look even more closely at its margins. If the company can improve margins the way management thinks it can with its combination with the transportation segment, then the stock could jump as a result. Growing sales plus higher margins equals one very attractive situation.
It's also encouraging to see the company's innovation in in-flight technology. For Bombardier, the company plans to implement wireless Internet access for passengers. Or in Honeywell's language, install its JetWave Ka-Band satellite connectivity systems. It's expected to go live in 2015. This should give revenues a slight boost going forward.
So, we've seen three reasons shares of Honeywell can go higher -- the stock's year-to-date underperformance coupled with raised full-year guidance, expanding margins/improved profitability for the upcoming quarter, and its growing aerospace business.
It doesn't hurt that the stock isn't expensive, either. With a P/E ratio of just 18.7, it's below the "diversified industrials" industry average of 19.8 and the industrial sector average of 24, as well as the S&P 500's.
Aside from having bullish catalysts and being undervalued, Honeywell also pays a nice dividend of yield of almost 2%. Let's see what the company can do when it reports earnings on October 17.
Bret Kenwell has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.