Following its aborted bid for United Technologies (NYSE:RTX), Honeywell International's (NYSE:HON) 2016 investor conference gave management an opportunity to redefine its strategic future to the analyst community. In the end, management outlined a mix of near- and long-term catalysts that should help investors decide what to do with the stock. Let's take a closer look at them.
1. United Technologies bid not an admission of a strategy change
CEO Dave Cote began the conference by asking analysts to think beyond the United Technologies bid and refocus on Honeywell's growth opportunities. Frankly, the deal made a lot of sense. Within aerospace, Honeywell is strong in avionics, and United Technologies is strong in mechanical actuated systems and engines; a merger may not have triggered debilitating anticompetitive concerns.
Moreover, Honeywell's strength in building controls systems might have complemented United Technologies' heating, ventilation, and air conditioning solutions (Carrier) and its Otis elevator business. However, United Technologies' management didn't want to play ball. Honeywell walked away.
All told, Cote argued that the bid didn't mean Honeywell was necessarily looking for a major acquisition, and the company has growth prospects of its own. Still, that he entertained taking on United Technologies is an indication that conditions are ripe for Honeywell to make a large acquisition, so keep an eye on events.
2. Calling a bottom in its oil and gas business
In the last year or so, investing in an industrial stock with a significant oil and gas component has been a punishing exercise. Honeywell estimates 14% of its sales will come from oil and gas.
However, it's not all doom and gloom. In fact, Honeywell's oil and gas business has growth prospects for three main reasons:
- The majority of its oil and gas revenue comes from downstream operations -- which theoretically should receive a boost from lower oil prices.
- Cote argued that many of Honeywell's solutions help customers optimize assets and are less likely than, say, upstream exploration capital spending in the current cycle.
- Increasing demand for refining capacity benefits Honeywell's refining catalyst demand (UOP) and process solutions technology (HPS).
All told, Cote predicts that Honeywell's oil and gas operations will pass an inflection point in 2016 and deliver around $200 million in revenue growth in 2017.
3. Aerospace set for long-term growth
In common with United Technologies, Honeywell faces headwinds in its commercial aerospace operations in 2016. In both cases, it's a consequence of new airplanes entering the marketplace. United Technologies forecasts aerospace systems operating profit growth to be flat to negative $50 million because of negative effects on volume mix (to the tune of around $325 million to $300 million) of selling newer, initially lower-margin, products.
Meanwhile, Honeywell is giving incentives to get new aircraft platforms in order to spur long-term growth. Honeywell Aerospace CEO Tim Mahoney produced a useful slide outlining the specific programs, with heavy exposure to three highly successful programs. For reference, the Boeing 737 MAX has 3,073 unfilled orders to February, with the Boeing 777 X at 306 unfilled orders, and the Airbus 350 at 777 orders.
4. Growing software and industrial Internet of Things
It wouldn't be a presentation by a major industrial company without a segment on the industrial Internet, and clearly it isn't just lip service with Honeywell. Half of its engineers are employed in developing software, and management expects 77% of its growth from its breakthrough initiatives in the next five years to involve a software component. All of this is intended to lead to 66% of aerospace sales and 81% of automation and control systems sales containing software by 2020.
5. Segment margins will continue to grow
Honeywell managed to expand adjusted operating margin by 280 basis points to 17.9% in 2015, and despite core organic growth only increasing 1% (reported sales were down 4%), the result was adjusted EPS growth of 10%.
The good news is that despite management forecasting just 1% to 2% organic sales growth for 2016 (leading to adjusted EPS growth of 6% to 10% in 2016), margin expansion is set to continue in the coming years.
Where next for Honeywell International?
All told, it was a pretty good presentation that helped investors refocus on the underlying growth prospects at the company. Ongoing margin expansion in the near term while building long-term profit growth through investments in the industrial Internet and getting on aerospace programs provides the stock with a compelling mix of attributes.
With or without United Technologies, Honeywell International is an attractive stock.