When companies like Honeywell International (NYSE:HON) report earnings, it's easy to get bogged down in the top- and bottom-line numbers. But what drives those numbers and how management feels about the future are arguably more important to investors.
With that in mind, here are the five things I took away from Honeywell's recent conference call with investors and analysts.
Margins are the name of the game
"Our top-line growth was respectable in this softening macro environment and our relentless focus on execution once again resulted in outstanding margin expansion and cash conversion while continuing to do the seed planting for a bright future. Our segment margin expanded 190 basis points to 19.3%."
-- Dave Cote, CEO
The story of Honeywell lately has been that of disappointing sales growth but rapidly expanding margins. A focus internally on operations has combined with management divesting from lower-margin businesses, leading to the 5% decline in sales -- although there was 1% organic sales growth -- and 8.3% increase in net income last quarter.
If the comments below are any indication, the plan is to continue that trend in the future.
Wifi for the skies
"Honeywell's partner Inmarsat successfully launched the third Global Xpress or GX satellite. The latest launch completes the GX satellite constellation, which will ultimately provide passengers, air crews, and operators with high-speed Internet connectivity anywhere in the world, including on transoceanic flights."
One interesting growth opportunity for Honeywell is in-aircraft Wifi. The company has partnered with Inmarsat to build a global satellite network for aircraft, and Honeywell will be providing the needed hardware on the plane. This expands the company's presence onboard aircraft, and could be an opportunity for upgrades in thousands of planes worldwide.
Low oil prices help Honeywell
"Finally, as we discussed, our pricing model in Resins and Chemicals protects profit dollars in a period of lower selling prices, thereby increasing the margin rate. So another solid quarter of margin improvement, driven by our operating system and key process initiatives."
One of the strange things about Honeywell's results is that the company can increase margins despite lowering prices. This is because it's passing through cost savings from low oil prices, and therefore lower resin and chemical costs, to customers.
If oil prices stay low, these savings will continue to help margins where pass-through pricing exists. But if oil goes up, it will help the energy business, so the company is really well positioned either way.
VW is no big deal
"I wanted to explain why [VW's diesel business] is far from a disaster for Honeywell, and in fact it's still an organic growth story. First, while we value the relationship with VW, as we do every customer, our sales to VW represents less than 1% of total Honeywell sales. So, while significant, we're not dependent on any one vehicle manufacturer globally."
-- Tom Szlosek, CFO
Honeywell has talked about turbochargers being a big potential business for it, so with VW's troubles in the diesel market, investors have to be concerned about that business. The good news is that it's a small percentage of Honeywell's sales and won't impact earnings much going forward. Management tried to spin VW's issues as a blip on diesel's radar, and seemed to think more diesel engines will be on the way in the future. That remains to be seen.
The bad news is that this appears to be a potential drag on the business in the future rather than a benefit, which isn't what management hoped for.
The future looks strong
"Moving to the fourth quarter of 2015, we're expecting another quarter of double-digit earnings growth to cap off the year. EPS excluding pension mark-to-market adjustment is expected to be approximately down 58%, up 10% year-over-year. Total Honeywell sales are expected to be $10 billion to $10.2 billion or up 1% to 2% on a core organic basis. Segment margins are expected to be up approximately 120 to 140 basis points."
The fourth quarter should continue the pattern of slow revenue growth but strong earnings growth for Honeywell. This isn't a growth story for investors, but the company's focus on high-value products and operational improvements is paying off.
The next step is to turn strong margins and cash flow into strong organic sales. Honeywell hasn't proven its ability to do that, and until it does, the upside potential on this stock will be limited.