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Honeywell (HON) provides mobile computing and scanning facilities under its business segment "Automation and Control Systems". In a bid to enhance its portfolio in this segment, the company completed the acquisition of Intermec on Sept. 17, 2013 for around $600 million. Honeywell announced its intent to acquire Intermec last year, and the company received shareholder approval in March 2013.

Intermec produces radio frequency identification device, or RFID, barcode printers and scanners. RFID is a chip used to identify electromagnetic tags attached with objects. With this deal, we expect the company will be able to grow in the RFID market since it's relatively new to this market. Honeywell launched its first ever RFID enabled device last year, whereas Intermec is a stronger player in global RFID market. We feel Honeywell is well positioned to gain in the robust RFID market, which is expected to grow at a compounded annual growth rate of 18% to $19.3 billion over the period of 2011-2014 due to technological advancements in RFID devices.

With this acquisition, Honeywell will not only benefit from Intermec's RFID, but it will open other new horizons for Honeywell as well. This is substantiated by Roger Fradin, head of Honeywell's Automation and Control solutions business, who stated, "While Intermec strengthens our core scanning and mobile computing business, it opens up entirely new opportunities in voice solutions, barcode, and receipt printing segments that we currently don't serve."

Honeywell's Automation and Control Systems segment is the highest revenue generating segment of Honeywell, accounting for 42.16% of Honeywell's total revenue in fiscal year 2012. However, this segment grew only 2% year over year in fiscal year 2012. Although this segment registered low growth in the last fiscal year, we feel Intermec's acquisition will aid the company to ramp up this low growth in revenue going forward. We expect that the company will benefit most from the growing RFID market, which is growing at a rapid pace of 18%.

Outperforming peers

Honeywell clearly outperforms its peers based on its year over year sales growth, operating margin, and earnings per share, or EPS. The first chart below compares Honeywell's year over year sales to its peers' average in the last two years. The operating margin is the amount left with a company after paying off its variable cost like wages and raw material. Consequently, an increasing operating margin is considered better. Additionally, in the last two years, Honeywell's EPS outperformed peers' average. All these factors are clearly depicted in the chart below and favor the growth potential of Honeywell.

(click to enlarge)

Source: Company's report

Valuation:

Honeywell's major rivals are Danaher (DHR) and 3M Company (MMM). How is Honeywell performing compared to its major rivals?

A stock with a lower forward PE ratio compared to its trailing PE ratio is undervalued. Honeywell's forward price to earnings, or PE, ratio is 15.20, significantly lower than its trailing twelve months PE of 21.01. As compared to its peers, Honeywell's stock is undervalued, as are all its competitors. Each has a forward PE slightly lower than their respective twelve months trailing PE ratio.

Valuation Parameter

Honeywell

Danaher

3M Company

Industry

Trailing PE ratio

21.01

19.64

18.93

16.7

Forward PE ratio

15.20

18.15

16.36

-

Return on equity (%)

23.9

12.8

25.20

15.7

P/B ratio

4.82

2.36

4.65

-

Source: Finviz.com

Honeywell's ROE is better than Danaher and the industry, though a little lower than that of 3M Company. We have also analyzed Honeywell based on price to book value, or P/B ratio. A low P/B ratio is considered better. Although Honeywell's P/B ratio is higher than its peers' P/B ratio, it isn't significantly higher than 3M Company's P/B.

These valuation parameters suggest that Honeywell's stock is currently undervalued and is expected to grow in the future.

Upside in dividend

By examining a company's earnings growth rate, we can analyze its dividend growth rate. For obtaining dividend growth on this basis, our calculation is based on ROE and earnings retained by Honeywell.

In this case, we are considering the ROE and dividend payout ratio to be constant for the next twelve months. Dividend payout ratio is the portion of earnings that a company pays in the form of dividend to the investors, and (1- dividend payout ratio) signifies the earnings retained by the company after paying out the dividend. Return on equity is a measure of company's profitability, which we discussed above. The product represents growth in dividend of the company.

Company

Dividend payout ratio (trailing twelve months)

(1-Dividend payout ratio)

(A)

ROE (trailing twelve months) (B)

Dividend growth

(A*B)

Honeywell

0.395

0.605

0.239

0.144

Since the trailing twelve months' dividend payout ratio and trailing twelve months' return on equity are considered constant for next twelve months, we estimate the dividend to grow by 14.4% for Honeywell for the next twelve months, as shown in the above table. The dividend goes in line with the above discussed acquisition. Since we expect the acquisition to boost the company's highest revenue generating segment, it will grow Honeywell's earnings. This in turn is expected to hike the company's dividend.

Conclusion

We expect that Honeywell will boost its automation and control solution segment with its acquisition of Intermec, as this acquisition will strengthen Honeywell's current facilities of this segment. This acquisition will also allow Honeywell to gain in markets like RFID, which is relatively new for the company. Honeywell's stock is also attractive compared to its peers based on its valuation. Considering the growth aspects and attractive valuation of Honeywell, we expect upside potential in its stock, which hints at a 'buy'.

Source: Honeywell: Where From Here?

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.