Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Investors in Honeywell (HON) are not pleased with the "conservative" outlook for 2014, with both revenues and earnings falling short of consensus estimates. As shares have risen more than a third this year, the stock price has vastly outperformed the operational improvements, resulting in increased valuation multiples.

This, combined with slow growth and a more than fair valuation, leaves me standing on the sidelines.

2014 Guidance

On Tuesday, Honeywell released its 2014 outlook, seeing revenues between $40.3 and $40.7 billion, up 4 to 5% compared to 2013. Sales growth is driven by expected organic growth of 3 to 4%. Analysts were looking for 2014 revenues of $41.1 billion, as Honeywell's CFO calls global GDP growth not as robust as the company would like to see. This is important, as the company derives more than half of its total revenues from abroad.

On top of that, operating margins are seen up by 50 to 80 basis points compared to 2013, implying operating margins of 15.3 to 15.6%. This margin expansion is driven by an expected $125 million in saving as part of a long term restructuring program.

All of this will result in expected earnings per share growth of 8 to 12%, with earnings seen anywhere between $5.35 and $5.55 per share. Analysts were looking for 2014 earnings of $5.55 per share. CEO and Chairman Dave Cote commented on the outlook:

We expect 2014 to be another strong year for Honeywell with across the board growth in sales, margin, EPS, and free cash flow. Next year, we will complete our first 5 year plan and our 2014 outlook is reflective of the company being on track to achieve the long-term targets that were set in 2010. In fact, we've already achieved the low-end of our long-term margin target in 2013.

Valuation

Back in October, Honeywell reported its third quarter earnings. The company ended the quarter with $5.50 billion in cash and equivalents. Total debt stands at $8.61 billion, for a net debt position of $3.1 billion.

Revenues for the first nine months of the year came in at $28.7 billion, up 2.1% on the year before. Net earnings rose by 12.0% to $3.00 billion. Full year revenues are seen around $39 billion, with earnings around $4.90 per share, implying annual earnings of $3.8 billion.

Trading around $87 per share, the market values Honeywell at $68 billion. This values equity in the business at 1.7 times annual revenues and 17-18 times annual earnings.

Honeywell recently hiked its quarterly dividend to $0.45 per share, for an annual dividend yield of 2.1%.

Some Historical Perspective

Long-term investors in Honeywell have seen excellent returns driven by the very impressive run up in the shares post the financial crisis. From a peak around $60 in 2007, shares more than halved to lows of $25 during the crisis. Ever since, shares have seen a steady but impressive recovery to current all-time highs in the mid to high eighties.

Underlying these returns is Honeywell's five year plan. Between 2009 and 2013, Honeywell is expected to grow its annual revenues by a cumulative 30% to $39 billion. Earnings rose sharply from $1.5 billion to $3.8 billion in the meantime following impressive margin expansion.

Investment Thesis

Honeywell has great business diversification, and these diverse businesses within its portfolio moderate both the cyclical upswings as well as downturns. Under its long term plan, Honeywell has boosted margins in every major business unit this year, and is expected to do so again in 2014.

On top of that, every business unit is expected to display topline growth in 2014. While aerospace revenues are seen between flat and plus 2%, growth in the transportation, automation and control, and performance materials business is seen anywhere between 3 and 7%. Merger and acquisition activity, a solid backlog and further momentum in the recovery cycle, are the drivers behind this growth.

All of this could lead up to $4 billion in free cash flows next year, allowing Honeywell to boost its capital expenditures budget by 30% to $1.2 billion to boost organic growth rates. Cash is further intended for merger and acquisition opportunities and dividends.

Back in April, when Honeywell acquired RAE Systems in a $340 million deal, I last took a look at the company's prospects. Shares traded around $75 per share at the time of writing, as I concluded to remain on the sidelines, citing modest revenue growth despite margin expansion opportunities.

Shares have continued to increase, notably on the back of these savings and the general strong market performance ever since, as I see no reason to change my opinion.

Source: Honeywell - 'Conservative' 2014 Outlook Comes In A Bit Low