By Matt Doiron
Honeywell (HON) rose on April 19th after reporting decent results for the first quarter of 2013. According to the company's 10-Q, net sales were flat versus a year earlier though higher gross margins helped earnings rise by 17%. The manufacturer of industrial technology products, instruments, and materials generated about $340 million in cash flow from operations during the quarter, most of which went to investing activities.
While the increase in net income is certainly a positive sign, however, the lack of change on the top line suggests that Honeywell cannot count on similar growth rates going forward (unless revenue starts to increase as well). The company is buying back some shares, but the effect on EPS is not particularly strong: cash used on repurchases is less than that used on dividends, and the yield is not very high at 2.2%. With Honeywell trading at 19 times trailing earnings, the valuation is therefore calling for earnings per share to continue to increase- likely at double-digit rates- for the next few years. That is what Wall Street analysts are expecting in fact, and as a result the forward P/E is 14. Even if Honeywell does hit that target the company would need to continue to do well to justify the current valuation, so we are at least somewhat skeptical that it is a buy at these prices.
We track quarterly 13F filings from hedge funds and other notable investors as part of our work developing investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year) and can use this database to find individual funds with positions in Honeywell as of the end of December. Adage Capital Management, managed by Phil Gross and Robert Atchinson, increased their stake during the fourth quarter to a total of 6.7 million shares (see Adage's stock picks). Billionaire Mario Gabelli's GAMCO Investors reported owning 2.7 million shares of Honeywell in its 13F (find Gabelli's favorite stocks).
BorgWarner (BWA) and Johnson Controls (JCI) are two of Honeywell's peers. These stocks trade at about the same levels as Honeywell in terms of trailing earnings, with P/E multiples in the 18-20 range. The sell-side is also expecting slightly higher growth rates, with the result being that each company is priced at a small discount to that company in terms of projected earnings for the forward fiscal year. BorgWarner reported small declines in both revenue and earnings in its last quarterly report compared to the fourth quarter of 2011, though, so given where it is currently trading we would avoid the stock unless financials improve. At Johnson Controls, net income fell 17% over the same period; similarly, we just don't think it is a good idea to buy a struggling business with a trailing earnings multiple of about 20.
We can also compare Honeywell to United Technologies (UTX) and to General Electric (GE). These larger companies are each valued at 16 times their trailing earnings, representing a narrow discount to the other three peers we've reviewed. GE's Q1 actually looked a lot like Honeywell's: revenue was roughly unchanged, but earnings grew at a decent rate. While of course we'd have a similar concern here as we did at Honeywell- we can't expect GE to sustain earnings growth entirely through wider net margins- the few points' worth of a discount (or the 3.5% yield, for income investors) might make it worth watching. United Technologies recently reported a rise in revenue for its most recent quarter compared to the same period in the previous year, but this was entirely due to an acquisition. As a result the stock actually fell on the news despite a small earnings beat.
Honeywell and its peers are not looking too attractive at this time- although GE might get close to value territory if its earnings continue to improve, and there is a fairly high dividend yield there. Honeywell itself has been experiencing growth in net income, but without corresponding rises in revenue we are skeptical that this will continue to the degree which it needs to in order to make Honeywell a good value.