Honeywell International (NYSE:HON)
Presentation at Electrical Products Group Conference
May 20, 2013 7:30 a.m. ET
Dave Cote - President and CEO
Martin Sankey - Neuberger Berman
Well, in the first and most important news, totally unrelated to anything at Honeywell, but I was at the University of Virginia yesterday, Charlottesville, the Darden School, where my youngest son graduated with his MBA in the top 10% of his class, so I’m wearing my colors today. That has nothing to do with anything, I’m just too proud. I can’t stand it.
So for those of you who have been listening to a number of the Honeywell presentations over time, you’ll notice there’s not a lot new here. However, I think that consistency of message is important and consistency of strategy. And you’ve heard me say before that if you have a good strategy and you just execute against it day by day, quarter by quarter, it’s amazing where you get to in a few years. And I think that’s what we’ve been able to do.
Messages for today, we’ve outperformed, and hopefully you’ll end up seeing from some of the things that we discuss with you, that’s going to continue. This is the business model. I don’t think I’ve done a great job in the past of explaining this, and that’s why we spent more time on it at investor day.
But think of it as three pieces. The first is having a good portfolio, and that’s why you hear me talk about having great positions in good industries, for example, and why we work at globalizing.
The second is to do a great job with your internal processes. You’ll hear me talk about this. It’s making sure the machinery works. And especially if you’ve got 130,000 people. There’s tremendous value in just making sure the machinery works, so that every day, people are making the right decisions because they know what it is you’re trying to do.
The third piece of this is having a superb culture. And I know culture isn’t the most financially sexy thing to be talking about, but it really does work. If you build a good culture, and you apply it to a good portfolio and drive your internal processes, it really helps you to perform over time. So that’s the business model. We apply this to everything.
And you can see this works. Sales over the last 10 years have done very well, growing to about over $38 billion this year. Expanding margins, done very well, and we’ve done a great job returning value to share owners. Versus our peers, you can see that growth rate has accelerated on the sales and EPS side.
And this is one that I point to when anybody asks questions about when does the margin expansion stop. And it almost sounds like you guys are at a peak now. And the fact is, yeah, we’ve done better that we have historically, but historically we also didn’t do all that well. And if you take a look at where some of our high margin rate peers are, we’re still 300 basis points away. The slope of our line is better, but we still have plenty of room to go here. It’s not like this is untrod ground.
If we take a look at how our growth rate has accelerated from that awful beginning that we had, that many of you remember as well as I do, things have changed a lot as we got into this second eight years.
And when it comes to great positions in good industries, the first thing is to try to align yourself with good macro trends, and those are the macro trends we see, so that yeah, things can go up or down in a year, but over a long course of time, those macro trends are going to stay.
And then when you’re trying to pick what’s a great position, we always try differentiating with technology. In fact we've learnt that that’s what we do very well, and you’ve seen us divest businesses that we don’t - not want to be in businesses where technology changes so fast that someone’s new introduction two years from now totally supplants your business. But rather something where you can get something patentable. You hang on to it. It’s tough to design around it.
Very defensible positions, whether it’s with brand channels or just the technology we have. We stay away from stuff that has heavy government subsidy, that’s heavily reliant. You never saw us invest a lot, for example, in wind or solar, because whenever you’re having to rely on 30-60% tax credits, what the government gives, the government can take away. And it just always made me uncomfortable. In our acquisitions, we tend to do more bolt-ons and smaller deals.
This kind of displays our end markets. You can see there’s a real variety. We shared this chart at investor day. The point of it’s always to support diversity of opportunity. And what I mean by that is whether it’s macro trends, countries, businesses, products, there’s never any one thing that we’re so dependent upon that if it takes off, the company does great.
But by the same token, there’s never any one of those things that goes awry, doesn’t do so well, that kills the company, either. So instead, what we have is a lot of highly defensible positions and this diversity of opportunity is what supports our ability to continue sustainably growing.
Same thing when it comes to how do you look at the cycles. On this chart, we’ve broken out our early, mid, and late cycle businesses to give you a sense of how they perform over time. But because we have that kind of dispersion in where our businesses are in the cycle, again it helps us to continue to outperform.
This is how our global expansion has worked. This has been huge for us. We’ve gone from 41% of sales outside the U.S. to about 54-55% of our sales outside the U.S. The other way to think about it is that while the company has grown about 70% or 75%, U.S. sales have grown about 35%. Outside the U.S. it’s more than doubled. And that ability to continue to globalize is a big deal, because even though we’re at 55% with 75-80% of world GDP outside the U.S., it means we still have a lot of room to grow here, and it’s been working.
Our focus on high-growth regions is really driven by simple economics. If you take a look at where, over the next timeframe, $21 trillion of GDP growth occurring in the world, you can see more than half of it is in high-growth regions. So you have to be there.
Innovation, we talk about it all the time. You saw a lot of this at investor day, as we talked about a bunch of the new products we’ve had. This is one of our early start problems, because we had an empty pipeline. We have a very full pipeline of new product now, in every single business that we’re in. And new products drive sales, drive market share gain, create new markets even.
We never forget about the cost side, and all of Steve’s comments on the up front about focusing on cost is real. We do stay there, and we try to look at it pretty simply and not just break it out into R&D, SG&A, direct, indirect, salaried, hourly, all that stuff. Because it really is pretty simple. Cost comes from either companies that you pay or people that you pay. It’s really pretty simple.
And despite all the discussion I’ve had with my own folks in the past about how to look at things, it seems like this has worked better than anything we’ve ever done when it comes to just simply explaining to people how you have to manage cost. Because whenever you’re writing a check, you’re generally incurring a cost of some kind. And this organization effectiveness, which is what we’ve gone to in terms of managing overall labor costs, has been hugely effective as we have our own guys develop two-year and five-year plans.
That focus on [census] has worked a lot. Looking at labor costs and how do we think about it, let’s take a look at developed markets, this going back 10 years ago. Indexed to 100, you can see that while our sales are up about 50% using 2003, our actual overall census in developed markets is down about 8%. And if you take a look at high-growth regions, while sales are up significantly more than that, and that our census is up, it’s up nowhere near as much as the sales side. And there’s a lot of developed critical mass in a lot of these high-growth regions.
This one I’m really proud about, because I’m a big believer that whatever you’re doing for the organization, or how you’re thinking about census there, how you’re thinking about [OEF], you need to do the same thing at the top. So we measure our leadership, is what we call band five and above. Band five is like the big level that you need to get to.
So again, indexing back to 2003, you would see that while earnings have about tripled, sales are up 70%. The actual bonus pool, the amount of money that we spend on bonuses, is up only 13% during that time. And the actual number of band five and above is down 6%.
Because I really do believe that if you have high level positions and you put really good people in those jobs, they will find something to do. And what they find to do will involve other people. And as a result of that, you create a lot of work that maybe doesn’t add as much value as you might have thought. So we’ve done the same thing for ourselves, as we’ve done throughout the organization.
And it’s worked very well as we drive this One Honeywell culture. You don’t see any reorganizing a lot between [SPG] discussions. And of course succession planning is something I think about at all levels.
Productivity, you’ve heard us talk about this a lot. The Honeywell operating system is just getting to critical mass. Think of it as the Toyota production system Honewellized. I’m happy to explain what that means at some point.
But you can see that what happens is, when it comes to overall productivity, it doesn’t just put you on a new plateau. But your rate of acceleration improves from that point also. And that’s an important distinction, because you don’t just elevate your overall standard and stay there. The rate that you improve from that plateau increases, which is a big deal.
And functional transformation, think of it as HOS but for staff functions, like finance, IT, HR, etc. We used to be 9.5% of sales were there. Next year, we’ll be at 5.5%, and I still think there’s another 1.5 to 2 points of margin growth available just in this. And that’s just to get to world-class.
So people are already there. Again, I’m not driving to places that nobody’s ever gone before. But it gets us closer and closer to world class. And we make sure that service levels are improving at the same time. Because you hear me talk a lot about how business is about doing two seemingly conflicting things at the same time. This allows us to reduce overall cost, and at the same time improve quality of service.
Cash deployment, I’m sure somebody will ask the question, even though I’m going to be putting it up here on the chart. At the end of the day, we’re a good cash generator. We’re going to keep doing that. That’s where it starts. Always begin with investing in our businesses, then I want to make sure that we pay a good, competitive dividend, which we do.
Then when it comes to strategic M&A, as you know we’re very careful about doing that. We’ve got a very disciplined process that we continue to exercise, and I will. We’ve learned very well over the last 10 years how to do that, and we’re not going to lose our heads all of a sudden and do something silly.
Share buyback, we’re going to continue to be opportunistic. You saw our [unintelligible] in the fourth quarter of last year continued into the first quarter of this year. And when it comes to our pension, which has been a question in the past, except under the most dire of circumstances, there’s going to be no need for any pension contribution for at least the next three years. And if you take a look at our funding position versus our peers, we’re in very good shape there.
If we take a look at our end markets, and how things are going, you remember that pie chart that I showed you earlier. You’ll get a sense of an incredible sideways. That’s about all it’s doing. And it’s one of the reasons why I don’t want to get too bullish about anything that I see, any green shoots, as they get referred to sometimes.
There are some signs, like Europe orders, where you’d say gee, they’re actually going up. That seems hard to believe on a short cycle. The thing is, you just don’t know for sure. Is this something sustainable? Or is this something that moderates? So we’re seeing kind of a sideways movement, and that’s where we’re going to continue to plan. I just don’t think there’s any percentage in being more bullish than that right now.
2013, our guidance. You’re aware of what we did there. We did very well in the first quarter and we raised guidance by a nickel at the low end. And you’re familiar with all of this. Our long term outlook, I think we’re past what was considered.
When we first issued these, it was considered ambitious or aspirational, and I think it’s recognized now that we’re actually going to make this happen, despite all the headwinds that we’ve dealt with on both the sales growth side and the segment margin rate side. We’re going to make it happen. And we’ll be issuing another five-year plan when we get to next year. But we’re performing in accordance with what we said back then.
We’ve got a number of great growth drivers in each of these businesses. This is already done, the incremental opportunity over the next five years. So we feel pretty good about the pipeline of sales that we see coming in every single one of our businesses.
And evolution is a concept that I talk about a lot, because it’s something I believe in, whether you’re an individual, an organization, a company, a country. You always have to keep evolving. You have to keep getting better every single year. Because if you’re not doing that, and you’re not thinking about how things are changing, every 10 years you have to have a revolution. So if instead you’re evolving every single year, it just puts you into a much better position to be able to grow and take advantage of your markets.
There’s some things that are going to stay the same with that evolution, and that’s our foundation for execution. You’ve heard me say a lot of these things, especially “the trick is in the doing,” “compliance with intent rather than compliance with words.” A lot of how we drive the company. And One Honeywell culture is real. If you recognize where we started, with three separate ones, it’s a big change.
There’s a number of things, though, that do evolve, that do have to change over time. What our portfolio is can change over time. As industries change, or we saw something one way, it appears to be another. We have to be prepared to move with that.
Innovation is something that we’ve just got to be constantly thinking about the technologies that we have, because we want to be at the forefront of that. It’s good to have the kind of restructuring pipeline that we have. We’ve got $300 million or $400 million as you know still unspent when it comes to the projects that we can do.
And making sure that we keep doing that seed planting. Always thinking about what’s next, what’s going to be good now that we ought to be working on, because seven years from now it’s going to turn into something. So that combination of that consistency of execution combined with an ability to evolve, I think, is what helps us to stand out.
So we’re going to continue outperforming. We’ve got a great portfolio to do it with. One Honeywell works. We also apply that to our internal processes, and there’s a lot of juice left to be had in just making sure the machinery works. And we think there’s a lot of runway for us in the future.
I’ll assume that you look at the appendix on your own. There’s nothing that you want me to go through on that? I assume you guys don’t want to look at a stack of numbers.
You acknowledge your roots to TPS. I don’t know if seed planting is the same as breakthroughs, and I wonder if you use that specific process. And do you use Hoshin Kanri?
Now you’re getting beyond my ken.
Strategy deployment, policy deployment.
[Stretch] goal deployment? Sort of taking the strategy?
Yes, absolutely. That’s one of the fundamentals we use, is making sure that whatever the strategic goal is for the business, the factories, whatever, they’re deployed all the way down to people. That’s been a big, fundamental part of what we’ve done from the beginning.
And is there a way for it to float back up?
Yeah, through the suggestion work that they do. I forget the name that we have for all the suggestions, but there’s definitely a mechanism for doing that, and for being able to respond, and respond at different levels as needed. So the supervisor needs to respond, the plant manager, the business leader. Yes. I’d be happy to show you that. Because I know we do HOS tours now. We’d be happy to show you some of that.
Given that you’re going to give plans to 2018 in March of next year, it would seem that you plan to be around for at least five more years. Hopefully it’s even more than that. My question, though, is that given that, if you look at the big three leaders in your business, Roger, Andreas, Tim, they’re all too senior to possibly succeed you, really. And we’re starting to see the transition with Dave Anderson now. I’m just wondering how should we think about that playing out? Obviously not naming names, but will there be a pretty clear cut rolling over of people in the top businesses over the next year or two? Or is there something else with should be looking for?
There could be. [laughter] I would just promise you, I’ve always said, from a legacy perspective, and if you go back 10 or 11 years ago, when I first got there, there were three things I was saying. One is I wanted people who had been associated with me in any way to say, “God, I made a lot of money when that guy was there.” So whether it was an investor, customer, supplier. My own employees, they would look at it and say, “I made a lot of money when he was there.”
The second one is that we would be known as the place to go to for leadership. And that in general people didn’t leave, even though they were being asked to, because their opportunities inside were that good. The third one was that I wanted to be able to own my shares 10 years after I’d left, and that they’d still be doing well.
So that means people, process, culture have to be right, if that’s going to happen. So I can promise you that it’s one of those things I’ve had in mind since I got there, I guess 11 years ago now. And it’s uppermost in my mind now. And as much as I love my job, I know at some point, some day, I do have to leave. Even if I’m doing well, at some point, you’ll start to look at me and go, “Wait a minute, what happens next?” So I’ve got to make sure that I think about that. So I can promise you it’s top of mind, and all will be revealed in the fullness of time.
Dave, how are you thinking of China and India, two separate markets? Honeywell legacy had been behind in those areas. You’ve caught up a lot. You’ve got your [East for East] initiatives. But you know, the Indian economy seems to be in a holding pattern, and China is very uncertain right now. Is this a time for you to get more aggressive, take more share? Or put more resources? Maybe just talk about those markets, because a lot of companies don’t bring those markets up when that used to be all they’d talk about before.
I see them as two very different markets, even though both have over a billion people. India’s government really costs them 3 to 4 GDP points a year. The bureaucracy is just incredibly overwhelming and holds back the country a lot. It’s tough to see that changing much over the next 10 or 15 years. There’s still going to be a tremendous amount of intellect. I mean, there’s a lot of foundation to build from. But we’re going to think about it more as like a 4-5% economy over 10 years. It’s the right way to think about it and plan for it.
China I view very differently. And we tell our own guys, you know who your competition is today, but the greatest likelihood of where your next big global competitor is going to come from is China. Now, it could be from other places. It could be this wonderful new technology somebody comes up with. I’m not precluding the possibility that could happen. But in general, I think the way to think about our businesses is that the next big global competitor could come from China.
That means you have to be able to beat your Chinese competitor in China, because if you’re not, then you’re going to meet him in Western Europe or in the U.S. So I pay a lot of attention to China, and that’s why we have our effort at becoming a Chinese competitor. Because I think it is a huge opportunity, but at the same time it could be a real problem if you don’t address it correctly.
We’re going to continue to be aggressive in China when it comes to how we build our businesses, how do we get to more mid-market than we have, how do we get the second, third, fourth tier cities to make sure that we have the right kind of sales coverage? And I’d say that does have to be gaining share.
But I’m tremendously concerned and excited about the opportunity to do it, because it has the potential to just be this wonderful new market and really change the world. I like being a part of it, but at the same time, think it’s important to be there and recognize that’s most likely where your next competitor is coming from.
Martin Sankey - Neuberger Berman
As a follow up to Jeff’s question, I was reading the Fortune profile on you earlier this year, and one of the things that struck me about it is in your time you have gone through three CEO transitions in getting to your current place. And so how has that informed you as to how you want to run the process in terms of getting a team in place, or are you running a horse race? Survivorship, that sort of thing.
I’m probably not going to share a lot on that, but I think your point about that I’m very informed, having been involved in some of these. It’s an easy thing to make mistakes with. And it can be very unpleasant for everybody who’s involved. And you put your finger on something important there. I can just tell you that I think about it a lot, and wanting to make sure that we do it intelligently and that we end up picking the right person so that when I own my shares 10 years later, I still feel good about it. But I’m not going to be much more specific than that.
Question on the longer-term margin upside. You had a slide that showed that functional transformation could give you another point and a half to two. You’ve got 70% of your facilities still at bronze levels, so HOS has certainly plenty of upside. And you’ve got a new pipeline, or full pipeline of products. So if I do the math it looks like you’ve got at least 300 basis points of margin upside from where you stand today. Maybe you can just provide some color around that, what the timing might be, how much of a lift you need from markets to get there.
Well, I’m not going to issue my five-year plan until I get to March, so I can promise you that’s not going to happen until then. But all the things that you point to are the things that are going to help with margin expansion. And I’d much rather be expanding margins with growing sales. It’s a lot easier that way.
And that’s going to be one of the things that we have to think through for this next five-year plan. I don’t think now’s the time to be assuming any kind of rosy outlook. So we’re going to have to think through what kind of GDP and exchange assumptions do we want to make about what the future looks like. I can only promise you it’s uppermost in my mind again as we think about what we want to do there.
But all the things you pointed to are what’s going to allow us to expand margins. The new product pipeline, which results in greater value for the customer, but also greater margins for us. HOS finally getting to that bronze status, and everybody starting to evolve to silver and gold. Functional transformation is worth 1.5 to 2 points. Velocity of product development is tougher to measure. But the impact is real, especially as we evolve the platform strategies in all of our businesses.
So yeah, I feel pretty good about it. Who knows? You may be disappointed.
What’s your strategy for your defense business, especially in light of not only sequestration but what looks to be kind of a no-growth, declining growth market outside of that?
Defense, for us, is a little different than it is for other companies or businesses. Because for us defense is really more of a sales channel. It’s not so much a separate business. So we’ll sell pretty much the same jet engine on the commercial side as we sell on the military side. An APU is an APU. It’s really more of a different sales channel with some slightly different products.
That puts us in a very different position when it comes to how do we manage it. So, for example, engineers who are working on a defense product, those same engineers can work on a commercial product because it’s essentially the same product.
So for us its easier overall to manage, and we’re going to continue to be conservative there. If you’ll recall, when it came to sequestration, for example, and I guess this happens when you spend enough time in Washington, rather than think, “Oh my god, this is so unconscionable, so egregious, there’s no way they’ll let this happen,” we looked at it instead and said, “No, it will happen, because the amount of inertia and political indolence can be quite substantial, and we ought to just assume that that will happen, because it’s the easiest course.”
And we assumed it, it did happen, and we were well-prepared for it. And we’re going to continue to think that way. We’re better off, in general, being conservative in our sales planning, so that our cost position is in good line.
You mentioned in your prepared comments that short cycle order trends in Europe have gotten slightly better. So any color that you can provide there would be helpful.
Well, to use a phrase that I’ve heard the investment community use before, you can’t be sure whether this is the beginning of a trend, or just a dead at bounce. This could very well just be that the amount of destocking that has occurred, that you all of a sudden get some lift from there and then you kind of stay there.
But it has been encouraging to see. I’m not ready to declare any kind of victory on this, because I do believe Europe could very well, the next three years, see zero percent growth overall. So maybe one year they’ll be up 0.7 and there will be cheering, and then they’ll be down 0.3. But all in all, it’s still not going to be all that good.
And I think that’s the right way to think about it, because they’re just not showing any political leadership of any kind. They’re just continuing to argue and as long as you have a 67-year-old German who has to work so a 60-year-old Frenchman can retire, that’s not going to work. I think they’re going to have to sort all this stuff out. Just like in our own entitlement programs, this stuff needs to get talked about and sorted out.
And until they do, it just seems to me you’re better off assuming not much changes, and that economically it doesn’t get a lot better. So that’s the way we’re going to continue to think about Europe.
Continuing on near term concrete-ish points, your 2014 outlook has a slightly lower GDP of 3.2 for the planning period. Just wondering what that implies for 2014 per se. For GDP growth, global, to get to 3.2 for your cumulative period, what does 2014 look like in that scenario?
I’m not sure what the map looks like in that, but again, we’re not counting on all that much. I really think that for the next three years, the right way to think about it is U.S. grows at 2, Europe is zero, India around 4, China around 6 to 7. And that’s just the right way to think about it. And some years will be better, some years worse.
But unless something changes in terms of a political leadership, the dynamic there, I just don’t think there’s a real percentage in thinking much bigger than that. So that’s why we’re going to look at how do we continue to outperform given the tough environment. In the event we’re wrong, and the environment is better than that, terrific. We’ll be in great shape.
Can you give us an update on what you’re seeing for flight hour growth and airline spending behavior in the aftermarket through May?
Airlines are an interesting industry, as you know. And flight hour growth, which really, if you take a look at the variability of flight hour growth, a really bad year is down 4%. A really good year is up 5%. Generally, kind of bounces around in that 2-3% range. And that’s what we’re continuing to see, so flight hour growth we still think goes up this year. Not by a huge amount, more like 1-3%, in that kind of range.
But spares, as you know, will go along that line, will gyrate wildly. So you’ll see the down 40, up 30, up 20, down 30, until you get a period of stability when it kind of gets back together again. And some of what we’re seeing is that instability coming in. And we’ve seen it most recently in China. China generally grew pretty reliably, along with flight hours, and in this past quarter, because of some of the clamp downs they’ve put on on SOE spending, and Xi Jinping kind of exercising control, all of a sudden we saw spares volume go down like 35%, 40% in the space of a quarter.
They can do that for a period of time, but at some point it comes screaming back. When that point is, I can’t really say, but China, I’d say, has been the biggest driver. And some in Europe. We saw some of that in Europe too.
Let me make this last question from an investor directly. So I’ve got the piece of paper, and not mine. Organic growth has moved from below peer growth to in line with peers. Will seed planting yield to better than peer group organic growth? And I might add my two cents. Where would you see that, where do you expect that? And any favorites?
I would say the answer is yes. And I think as part of the trend that we’ve been able to build over time. And in terms of which businesses it will show up in, it’s always tough to predict, because we’re in a number of different industries, and some of those will take off at some point. I fully expect one of those that you’ll see at some point in the next two or three years is turbos. And when that takes off, as Alex was saying back at investor day, the growth will be explosive. Because he’s got the fixed cost on that [script] very low at this point. Our wins continue to be terrific. It feels like we’re kind of at the bottom. Can’t tell for sure. But it feels like we’re at the bottom, and sales are starting to look better. At some point, that could just be this tremendous boost. Same thing if flight hours start moving up at a quicker rate and airlines have to bring their spares back. That will happen. Non-residential construction, which as you all know tends to lag residential construction, that’s going to hit at some point here, and we’re already seeing increases in quote activity. It doesn’t mean it’s sales yet. Quotes don’t necessarily lead to sales, but it’s usually a good forward indicator. And PMT, of course, was everything that [UOP] is doing. At some point, all those projects start hitting. We’ve built this great backlog. So I can’t predict where and when exactly it will be, but I’m pretty confident it’s going to happen. And we’ve taken out, as you know, a number of the laggards, the stuff that didn’t grow quite as well. So between the absence of that, and the stuff that we’re in, I feel pretty confident that’s going to happen too.
Any closing comments?
You’d be disappointed, Steve, if I didn’t say this is an opportunity for you, so you should buy now while supplies last. Thank you very much. Nice to talk to you again this year.
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